Investing vs paying down mortgage

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masonary
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Investing vs paying down mortgage

Post by masonary »

Hello,

We just moved into a new house and am looking to balance my investments. Both of us are in early to mid 30s and our combined income is around 400-500k per year and have a mortgage of $1.3m. We have about 350k in pretax 401k and 125k in roth ira. We have ~400k in stocks/etfs and will have another 400k in cash from sale of our previous house. The mortgage rate is 2.375%. We do not have kids yet but do plan on starting a family soon. I don't have any other debt. I am looking for some advice on how to use this cash. How do I decide between paying down mortgage vs investing? If I go the route of investing, what are some ways to diversify beyond equity and bonds?

Thanks!
Grt2bOutdoors
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Re: Investing vs paying down mortgage

Post by Grt2bOutdoors »

masonary wrote: Sat Jun 12, 2021 4:36 pm Hello,

We just moved into a new house and am looking to balance my investments. Both of us are in early to mid 30s and our combined income is around 400-500k per year and have a mortgage of $1.3m. We have about 350k in pretax 401k and 125k in roth ira. We have ~400k in stocks/etfs and will have another 400k in cash from sale of our previous house. The mortgage rate is 2.375%. We do not have kids yet but do plan on starting a family soon. I don't have any other debt. I am looking for some advice on how to use this cash. How do I decide between paying down mortgage vs investing? If I go the route of investing, what are some ways to diversify beyond equity and bonds?

Thanks!
1) Is your income secure?
2) With a 2.375% rate, most equities will handily beat that rate of return over the long haul. You should focus on maximizing your retirement savings for both spouse and yourself. That is 401K, Roth IRA's and if your employer offers it - the ability to save on an after-tax basis in addition to your contributions of $19.5K each per year assuming you both work, and then rolling it into a Mega Back Door Roth IRA each year.
3) Alternatives? - like real estate? You already have huge exposure to real estate to the tune of at least $1.3MM, what other alternatives are you thinking of? Do you want to deal with tenants? The alternative is just buying a REIT index - domestically or a global reit index. I'd only consider alternatives like a limited partnership that owns real estate when your debt profile is lower and you have substantially more in assets.
4) IMO, i'd just focus on this order - retirement, 529 plan for when child arrives, pay off mortgage, enjoy life. Investing is simple, not easy though because the thought of "more" but you and spouse need to determine what is "enough".
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
Topic Author
masonary
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Re: Investing vs paying down mortgage

Post by masonary »

Thanks for the response. Our goal is to retire early, although we have not spent time on figuring out how much is enough. We save > 60% of post tax income (before the home purchase). We have decided to live in the HCOL area because we have family and friends here.

1. We are both in tech and I consider the income secure in the medium term.
2. We are maximizing retirements plans, this year we have put in the max possible amount back door roth with IRA(6k each), megaback door roth (only one of our employers allows it) and pre tax 401k.
3. I was thinking about real estate, but you are right that I already have a huge exposure with my current home. TBH, I do not know what the alternatives are and just going off on a vague idea that I need to diversify.
lakpr
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Re: Investing vs paying down mortgage

Post by lakpr »

@masonary,

May I interest you in a CD on which you can earn a guaranteed 4.5%, but the max you can invest is only $300k?

If you are looking for investing even more, could I interest you in another CD on which you can earn a guaranteed 3.65%, the max you can invest is only $250k (you must buy the CD aforementioned first)? Yeah, sorry, the incentive goes down a bit beyond $300k investment.

How much would you invest? You have $400k from the sale of the previous home, would you be interested in deploying part of the cash into either CD?

=========================

Of course I am not a bank and I truly don't have a CD to offer you, I just wanted to illustrate to you that the 2.375% rate you are paying on your mortgage, is a mirage. Are you aware that the mortgage interest paid on a principal balance over $750k is not tax-deductible? And are you also aware that in California (admittedly I made an assumption here that you are in CA, given that you said you are in Tech and your combined in come is $400k to $500k), mortgage interest on a principal balance over $1 million is not deductible on state taxes either?

But you have a $1.3 million mortgage.

That 2.375% interest you are paying, is completely after-tax interest.

If you pay down the mortgage to $1 million, you will begin to capture the full state tax benefit, but not the Federal tax benefit. That's where the first guaranteed rate of 4.5% on first $300k comes in, as that's the Taxable Equivalent Yield of 2.375% = (2.375% / 0.53 = 4.5%). 0.53 being 1 - 35% Federal tax rate - 12% California state tax rate on $400k annual income.

If you pay down the mortgage further to $750k, you will begin to capture the Federal tax benefit also, so for the principal amount between $1million and $750k ( = $250k), you will get the state tax benefit but not the Federal benefit, so your effective yield would be 2.375% / (1 - 35% Federal rate) = 3.65%.

========================

4.5% taxable equivalent yield is tremendous in today's extremely low yield environment. I would urge you to take it. In other words, at least pay down the mortgage to $1 million.

Depending on your risk tolerance and outlook, you might also want to pay it down further to $750k outstanding balance, to capture another 3.65% guaranteed yield.

Simply ask the lender to recast the mortgage after doing that, that would cut down your monthly outflow by almost half, and you can still get to invest the money in the taxable account. Except that you will be dollar-cost-averaging instead of investing lumpsum.

If you do decide to invest lumpsum into the market, just keep in mind that the break even rate you must earn is 4.5%. In any year the markets do not return at least this much to you, you would have lost money.
liftingbrosef
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Re: Investing vs paying down mortgage

Post by liftingbrosef »

lakpr wrote: Sat Jun 12, 2021 7:26 pm @masonary,

May I interest you in a CD on which you can earn a guaranteed 4.5%, but the max you can invest is only $300k?

If you are looking for investing even more, could I interest you in another CD on which you can earn a guaranteed 3.65%, the max you can invest is only $250k (you must buy the CD aforementioned first)? Yeah, sorry, the incentive goes down a bit beyond $300k investment.

How much would you invest? You have $400k from the sale of the previous home, would you be interested in deploying part of the cash into either CD?

=========================

Of course I am not a bank and I truly don't have a CD to offer you, I just wanted to illustrate to you that the 2.375% rate you are paying on your mortgage, is a mirage. Are you aware that the mortgage interest paid on a principal balance over $750k is not tax-deductible? And are you also aware that in California (admittedly I made an assumption here that you are in CA, given that you said you are in Tech and your combined in come is $400k to $500k), mortgage interest on a principal balance over $1 million is not deductible on state taxes either?

But you have a $1.3 million mortgage.

That 2.375% interest you are paying, is completely after-tax interest.

If you pay down the mortgage to $1 million, you will begin to capture the full state tax benefit, but not the Federal tax benefit. That's where the first guaranteed rate of 4.5% on first $300k comes in, as that's the Taxable Equivalent Yield of 2.375% = (2.375% / 0.53 = 4.5%). 0.53 being 1 - 35% Federal tax rate - 12% California state tax rate on $400k annual income.

If you pay down the mortgage further to $750k, you will begin to capture the Federal tax benefit also, so for the principal amount between $1million and $750k ( = $250k), you will get the state tax benefit but not the Federal benefit, so your effective yield would be 2.375% / (1 - 35% Federal rate) = 3.65%.

========================

4.5% taxable equivalent yield is tremendous in today's extremely low yield environment. I would urge you to take it. In other words, at least pay down the mortgage to $1 million.

Depending on your risk tolerance and outlook, you might also want to pay it down further to $750k outstanding balance, to capture another 3.65% guaranteed yield.

Simply ask the lender to recast the mortgage after doing that, that would cut down your monthly outflow by almost half, and you can still get to invest the money in the taxable account. Except that you will be dollar-cost-averaging instead of investing lumpsum.

If you do decide to invest lumpsum into the market, just keep in mind that the break even rate you must earn is 4.5%. In any year the markets do not return at least this much to you, you would have lost money.
This is an amazing post!
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masonary
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Re: Investing vs paying down mortgage

Post by masonary »

Thank you! This is an amazing post.
lakpr wrote: Sat Jun 12, 2021 7:26 pm @masonary,

May I interest you in a CD on which you can earn a guaranteed 4.5%, but the max you can invest is only $300k?

If you are looking for investing even more, could I interest you in another CD on which you can earn a guaranteed 3.65%, the max you can invest is only $250k (you must buy the CD aforementioned first)? Yeah, sorry, the incentive goes down a bit beyond $300k investment.

How much would you invest? You have $400k from the sale of the previous home, would you be interested in deploying part of the cash into either CD?

=========================

Of course I am not a bank and I truly don't have a CD to offer you, I just wanted to illustrate to you that the 2.375% rate you are paying on your mortgage, is a mirage. Are you aware that the mortgage interest paid on a principal balance over $750k is not tax-deductible? And are you also aware that in California (admittedly I made an assumption here that you are in CA, given that you said you are in Tech and your combined in come is $400k to $500k), mortgage interest on a principal balance over $1 million is not deductible on state taxes either?

But you have a $1.3 million mortgage.

That 2.375% interest you are paying, is completely after-tax interest.

If you pay down the mortgage to $1 million, you will begin to capture the full state tax benefit, but not the Federal tax benefit. That's where the first guaranteed rate of 4.5% on first $300k comes in, as that's the Taxable Equivalent Yield of 2.375% = (2.375% / 0.53 = 4.5%). 0.53 being 1 - 35% Federal tax rate - 12% California state tax rate on $400k annual income.

If you pay down the mortgage further to $750k, you will begin to capture the Federal tax benefit also, so for the principal amount between $1million and $750k ( = $250k), you will get the state tax benefit but not the Federal benefit, so your effective yield would be 2.375% / (1 - 35% Federal rate) = 3.65%.

========================

4.5% taxable equivalent yield is tremendous in today's extremely low yield environment. I would urge you to take it. In other words, at least pay down the mortgage to $1 million.

Depending on your risk tolerance and outlook, you might also want to pay it down further to $750k outstanding balance, to capture another 3.65% guaranteed yield.

Simply ask the lender to recast the mortgage after doing that, that would cut down your monthly outflow by almost half, and you can still get to invest the money in the taxable account. Except that you will be dollar-cost-averaging instead of investing lumpsum.

If you do decide to invest lumpsum into the market, just keep in mind that the break even rate you must earn is 4.5%. In any year the markets do not return at least this much to you, you would have lost money.
lakpr
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Re: Investing vs paying down mortgage

Post by lakpr »

@liftingbrosef and @masonary,

Thank you for your kind words and really glad you found my post useful!
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JonnyDVM
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Re: Investing vs paying down mortgage

Post by JonnyDVM »

Firmly disagree with the notion of paying down a 2.375% mortgage. If the market doesn’t return better than that over the long haul, we’re all doing it wrong.

For years on this forum I’ve observed people here advocating paying down these low rate mortgage rates over investing. For anyone that listened, the opportunity cost has been enormous. You’re in your early 30s. You have decades before retirement. Barring complete economic collapse of the United States paying that down over investing is going to cost you an enormous amount of money in the long run.
Last edited by JonnyDVM on Sun Jun 13, 2021 6:46 am, edited 1 time in total.
I’d trade it all for a little more | -C Montgomery Burns
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JonnyDVM
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Re: Investing vs paying down mortgage

Post by JonnyDVM »

liftingbrosef wrote: Sat Jun 12, 2021 8:22 pm
lakpr wrote: Sat Jun 12, 2021 7:26 pm @masonary,

May I interest you in a CD on which you can earn a guaranteed 4.5%, but the max you can invest is only $300k?

If you are looking for investing even more, could I interest you in another CD on which you can earn a guaranteed 3.65%, the max you can invest is only $250k (you must buy the CD aforementioned first)? Yeah, sorry, the incentive goes down a bit beyond $300k investment.

How much would you invest? You have $400k from the sale of the previous home, would you be interested in deploying part of the cash into either CD?

=========================

Of course I am not a bank and I truly don't have a CD to offer you, I just wanted to illustrate to you that the 2.375% rate you are paying on your mortgage, is a mirage. Are you aware that the mortgage interest paid on a principal balance over $750k is not tax-deductible? And are you also aware that in California (admittedly I made an assumption here that you are in CA, given that you said you are in Tech and your combined in come is $400k to $500k), mortgage interest on a principal balance over $1 million is not deductible on state taxes either?

But you have a $1.3 million mortgage.

That 2.375% interest you are paying, is completely after-tax interest.


If you pay down the mortgage to $1 million, you will begin to capture the full state tax benefit, but not the Federal tax benefit. That's where the first guaranteed rate of 4.5% on first $300k comes in, as that's the Taxable Equivalent Yield of 2.375% = (2.375% / 0.53 = 4.5%). 0.53 being 1 - 35% Federal tax rate - 12% California state tax rate on $400k annual income.

If you pay down the mortgage further to $750k, you will begin to capture the Federal tax benefit also, so for the principal amount between $1million and $750k ( = $250k), you will get the state tax benefit but not the Federal benefit, so your effective yield would be 2.375% / (1 - 35% Federal rate) = 3.65%.

========================

4.5% taxable equivalent yield is tremendous in today's extremely low yield environment. I would urge you to take it. In other words, at least pay down the mortgage to $1 million.

Depending on your risk tolerance and outlook, you might also want to pay it down further to $750k outstanding balance, to capture another 3.65% guaranteed yield.

Simply ask the lender to recast the mortgage after doing that, that would cut down your monthly outflow by almost half, and you can still get to invest the money in the taxable account. Except that you will be dollar-cost-averaging instead of investing lumpsum.

If you do decide to invest lumpsum into the market, just keep in mind that the break even rate you must earn is 4.5%. In any year the markets do not return at least this much to you, you would have lost money.
This is an amazing post!
The bolded part is simply not true. The interest on 750k is quite deductible. OP will hit the SALT cap, but that doesn’t mean the mortgage interest isn’t deductible. So I wouldn’t say this is amazing. I would say it uses a false narrative to inflate the rate OP is actually paying.
I’d trade it all for a little more | -C Montgomery Burns
Ron Ronnerson
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Re: Investing vs paying down mortgage

Post by Ron Ronnerson »

In your circumstances, I would likely invest the money. However, it’s a personal decision and there are plenty of things you could do that are worse than pay down a mortgage. If the idea of investing $400k all at once seems like too much, you could split the difference and pay down the mortgage some and invest the rest.

This forum largely emphasizes keeping things straightforward with equities and bonds. I’d just stick with your asset allocation when it comes to investing the additional money but if you are looking for other investments, you can try real estate, precious metals, cryptocurrency, collectibles, and high-interest bank accounts as some ideas to consider.
lakpr
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Re: Investing vs paying down mortgage

Post by lakpr »

@JonnyDVM,

If you noticed, I never said that entire mortgage interest is not deductible. I stopped at the mortgage balance of $750k, the upper threshold at which the interest stops being deductible. Are you disagreeing that the true interest rate comparison should be on a before tax basis? Is there an error in my Math?
Last edited by lakpr on Sun Jun 13, 2021 7:34 am, edited 1 time in total.
UpperNwGuy
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Re: Investing vs paying down mortgage

Post by UpperNwGuy »

I would invest the money instead of paying down the mortgage.
PKD
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Re: Investing vs paying down mortgage

Post by PKD »

Full disclosure, I paid off our 30-year mortgage after 7 years. And we’re nowhere near retirement age. But I might not do it in your position.

I love not having a mortgage, and I’ve never regretted paying it off. But if the either/or can make a significant impact on your finances and investment outlook, you might not want to do it. I waited until it didn’t really make that much of a difference in the total amount of our liquid assets.
MoonOrb
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Re: Investing vs paying down mortgage

Post by MoonOrb »

Paying down the mortgage in these circumstances seems absolutely bananas to me. If all of your tax advantaged accounts are maxed, open a taxable account and pile money in there and watch it grow. Paying down a mortgage of course isn't the worst thing you could do. You could put that money under a mattress or you could invest it in your crazy uncle's get rich quick scheme or you could spend it all on an expanding consumer lifestyle--those would all be worse choices. Paying down a mortgage in circumstances where you are miles away from early retirement seems like a really poor choice.

If you're finding yourself with a vague idea about diversifying and not understanding what this is or why you should do it, read up on some of the basics around the 3 fund portfolio here on the wiki and go from there.
stoptothink
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Re: Investing vs paying down mortgage

Post by stoptothink »

PKD wrote: Sun Jun 13, 2021 11:48 am Full disclosure, I paid off our 30-year mortgage after 7 years. And we’re nowhere near retirement age. But I might not do it in your position.

I love not having a mortgage, and I’ve never regretted paying it off. But if the either/or can make a significant impact on your finances and investment outlook, you might not want to do it. I waited until it didn’t really make that much of a difference in the total amount of our liquid assets.
Same, we paid ours off in 4.5yrs (in our mid-30's) and I love it, but right now (and in OP's situation) it would be far down our list of financial priorities.
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JonnyDVM
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Re: Investing vs paying down mortgage

Post by JonnyDVM »

lakpr wrote: Sun Jun 13, 2021 7:30 am @JonnyDVM,

If you noticed, I never said that entire mortgage interest is not deductible. I stopped at the mortgage balance of $750k, the upper threshold at which the interest stops being deductible. Are you disagreeing that the true interest rate comparison should be on a before tax basis? Is there an error in my Math?
Yes, I am disagreeing. Settlng aside the fact that Claiforina tax would absolutely not be 12% on 400k of income anyway, it’s calculated with marginal tax brackets, not a flat gross

Secondly, investable money would also be subject to tax.
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ApeAttack
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Re: Investing vs paying down mortgage

Post by ApeAttack »

JonnyDVM wrote: Sun Jun 13, 2021 6:41 am Firmly disagree with the notion of paying down a 2.375% mortgage. If the market doesn’t return better than that over the long haul, we’re all doing it wrong.

For years on this forum I’ve observed people here advocating paying down these low rate mortgage rates over investing. For anyone that listened, the opportunity cost has been enormous. You’re in your early 30s. You have decades before retirement. Barring complete economic collapse of the United States paying that down over investing is going to cost you an enormous amount of money in the long run.
This is why I decided to stop paying down my 30yr 2.5% mortgage until I max out all my tax-advantaged accounts. If the markets do very well by the time I retire in 20 years, I can choose to pay off the mortgage early at that time.

Edit: Forgot to mention that by contributing to the tax-advantaged accounts, I get additional liquidity if an emergency occurs versus putting that money into paying down the mortgage. I might have to pay a penalty, but I can get access to most of the money.
Last edited by ApeAttack on Sun Jun 13, 2021 11:30 pm, edited 1 time in total.
Just another lazy index investor who recently found out about I-Bonds (https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm).
lakpr
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Re: Investing vs paying down mortgage

Post by lakpr »

JonnyDVM wrote: Sun Jun 13, 2021 1:35 pm
lakpr wrote: Sun Jun 13, 2021 7:30 am @JonnyDVM,

If you noticed, I never said that entire mortgage interest is not deductible. I stopped at the mortgage balance of $750k, the upper threshold at which the interest stops being deductible. Are you disagreeing that the true interest rate comparison should be on a before tax basis? Is there an error in my Math?
Yes, I am disagreeing. Settlng aside the fact that Claiforina tax would absolutely not be 12% on 400k of income anyway, it’s calculated with marginal tax brackets, not a flat gross

Secondly, investable money would also be subject to tax.
Yes we are talking about marginal rax rates. It is always based on the marginal tax rates, never effective. This is why when we ask folks to provide their portfolio details, we ask them to provide the marginal tax rates not effective tax rates. Effective tax rates don't mean anything.

The "secondly" point you wrote -- I am not sure how to interpret that. The investable money has already been taxed in any case, how is that relevant? It came into his possession after paying taxes, it is the question of where to invest it. Paying down the mortgage is a bond like yield, guaranteed 4.3% (see edit below); investing in stocks the return is not guaranteed. You may earn more than 4.3% or you may lose money. I have made neither any assumptions nor any recommendations as to what the OP should do, except to point out that he is effectively borrowing $300k at 4.3% and an additional $250k at 3.65% to invest in the market if he does choose to invest (the main question right there in the subject line of this thread).

(Edit: now that you called it out, Iooked up the CA tax rates, found that I made an error, I picked Single tax rate than Married Couple. The point remains, though:. Rather than 4.5% and 3.65%, the figures are 4.34% and 3.65%, does that distract from my point very much?).
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JonnyDVM
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Re: Investing vs paying down mortgage

Post by JonnyDVM »

lakpr wrote: Sun Jun 13, 2021 3:22 pm
JonnyDVM wrote: Sun Jun 13, 2021 1:35 pm
lakpr wrote: Sun Jun 13, 2021 7:30 am @JonnyDVM,

If you noticed, I never said that entire mortgage interest is not deductible. I stopped at the mortgage balance of $750k, the upper threshold at which the interest stops being deductible. Are you disagreeing that the true interest rate comparison should be on a before tax basis? Is there an error in my Math?
Yes, I am disagreeing. Settlng aside the fact that Claiforina tax would absolutely not be 12% on 400k of income anyway, it’s calculated with marginal tax brackets, not a flat gross

Secondly, investable money would also be subject to tax.
Yes we are talking about marginal rax rates. It is always based on the marginal tax rates, never effective. This is why when we ask folks to provide their portfolio details, we ask them to provide the marginal tax rates not effective tax rates. Effective tax rates don't mean anything.

The "secondly" point you wrote -- I am not sure how to interpret that. The investable money has already been taxed in any case, how is that relevant? It came into his possession after paying taxes, it is the question of where to invest it. Paying down the mortgage is a bond like yield, guaranteed 4.3% (see edit below); investing in stocks the return is not guaranteed. You may earn more than 4.3% or you may lose money. I have made neither any assumptions nor any recommendations as to what the OP should do, except to point out that he is effectively borrowing $300k at 4.3% and an additional $250k at 3.65% to invest in the market if he does choose to invest (the main question right there in the subject line of this thread).

(Edit: now that you called it out, Iooked up the CA tax rates, found that I made an error, I picked Single tax rate than Married Couple. The point remains, though:. Rather than 4.5% and 3.65%, the figures are 4.34% and 3.65%, does that distract from my point very much?).
I’ve read this original post a dozen times. It does not make any sense.

There is no magic bonus for paying down the mortgage to the level where the interest is deductible. OP is ALREADY maxing out that tax deduction.

OP takes 400k and pays down the non deductible portion of a mortgage loan at 2.375%. He’s saved the 2.375%, nothing more. Once OP gets into paying off the deductible portion of his mortgage now he’s saving LESS than 2.375%, not to mention we’ve lost 400k in liquidity.

OP takes 400k and invests it. He has to do worse than 2.35% (plus long term cap gains) to not come out ahead.

If we’re taking 400k and investing in a bank CD, ok I agree OP would come out ahead paying off a loan at 2.375. But OP wouldn’t/shouldn’t do that. The stock market over OPs investing horizon will absolutely return better than that. If it doesn’t we’re all ruined.
I’d trade it all for a little more | -C Montgomery Burns
lakpr
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Re: Investing vs paying down mortgage

Post by lakpr »

JonnyDVM wrote: Sun Jun 13, 2021 3:33 pm I’ve read this original post a dozen times. It does not make any sense.

There is no magic bonus for paying down the mortgage to the level where the interest is deductible. OP is ALREADY maxing out that tax deduction.

OP takes 400k and pays down the non deductible portion of a mortgage loan at 2.375%. He’s saved the 2.375%, nothing more. Once OP gets into paying off the deductible portion of his mortgage now he’s saving LESS than 2.375%, not to mention we’ve lost 400k in liquidity.
You keep saying "it does not make any sense" but I am not seeing a cogent argument around why. You keep talking about 2.375% rate, but that is AFTER-TAX rate he is paying on a principal balance of ($1.3 million - $750k threshold) = $550k balance. On $300k of that balance he is paying 2.375% rate, and on the next $250k of that balance he is paying 2.375% * (1 - 9.3% California tax rate) = 2.15% after-tax interest rate.

To earn a 2.375% after-tax interest rate, one must earn an equivalent of 4.3% in a taxable account, and to earn 2.15% after-tax interest rate one must earn an equivalent of 3.65% in a taxable account.

I have specifically used the term TEY (Taxable Equivalent Yield) in my post.

If your comparison on after-taxes basis "makes sense", equally so does my comparison on a before-taxes basis. If your argument is that by using before-tax figures is exaggerating the issue at hand, I can equally argue back that you are minimizing the issue by using the after-taxes basis.

Liquidity loss IS addressed in my post. Note that I specifically recommended, *IF* the OP takes the route of paying down the mortgage to $750k remaining balance, ask the lender to immediately recast the loan. That should immediately reduce the monthly outflow to half of what it is now, and that liquidity is regained -- which he can deploy into the market. With the associated explanation that it is the equivalent of dollar-cost-averaging into the market rather than investing all that $550k at once.
JonnyDVM wrote: Sun Jun 13, 2021 3:33 pm OP takes 400k and invests it. He has to do worse than 2.35% (plus long term cap gains) to not come out ahead.
This is true only if the OP would invest the entire $400k into stocks. If he chooses target date funds or target risk funds, or worse, pure bond funds, he is essentially borrowing at 4.3% and 3.65%, and turning around and lending around 1.3% to 2.1% to others.
JonnyDVM wrote: Sun Jun 13, 2021 3:33 pm If we’re taking 400k and investing in a bank CD, ok I agree OP would come out ahead paying off a loan at 2.375. But OP wouldn’t/shouldn’t do that. The stock market over OPs investing horizon will absolutely return better than that. If it doesn’t we’re all ruined.
I have neither made any assumptions nor any specific recommendations that he must pay down the mortgage. I was pointing that by choosing to invest in the market, he is essentially borrowing at the rate of 4.3% and 3.65% , and must earn at least that much to gain on his investments. It may "absolutely" return that much, or not ... it is not guaranteed. I haven't forgotten the lost decade when the stock market returns including dividend reinvestments are 0.5% over 10 years (1999 to 2009).

Regarding the long term capital gains, at his bracket he is subject to NIIT, so the true LTCG tax rate is 18.8% on Federal + 9.3% on California state, for a cumulative tax rate of 28.1%. Even if we take this 28.1% rate (which assumes 100% investment in purely stocks), the Taxable Equivalent Yield (TEY) he must earn is 2.375% ÷ (1 - 28.1%) = 3.3%. In any year the stock market returns less than 3.3% (2018!) he lost money. If we take the last two decades, there have been 6 such years (2001 to 2021 year-to-date). So roughly 1 in 3 years he may lose money.

Guess what -- roughly 1 in 3 is also the chance that he would gain the money by dollar cost averaging instead of choosing lump sum.
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grabiner
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Re: Investing vs paying down mortgage

Post by grabiner »

JonnyDVM wrote: Sun Jun 13, 2021 6:41 am Firmly disagree with the notion of paying down a 2.375% mortgage. If the market doesn’t return better than that over the long haul, we’re all doing it wrong.

For years on this forum I’ve observed people here advocating paying down these low rate mortgage rates over investing. For anyone that listened, the opportunity cost has been enormous. You’re in your early 30s. You have decades before retirement. Barring complete economic collapse of the United States paying that down over investing is going to cost you an enormous amount of money in the long run.
And the same argument also applies to anyone who invests in bonds; the opportunity cost is even greater, as the benefit of investing in stocks is the same whether the alternative investment is bonds or a mortgage, while the bond yield is lower than the mortgage rate. However, it isn't common to invest 100% in stocks, because many investors do not have that risk tolerance.

Thus, if you are planning to hold some bond investments, and don't need the liquidity from investments, it is better to pay down a mortgage rather than invest in lower-yielding bonds. If you are planning to invest 100% in stocks, keeping the mortgage might be reasonable if that is consistent with your risk tolerance and allows you to hold even more in stocks. (And for stocks, comparing taxable equivalent yield is not fair, as much of the return from stocks is tax-deferred.)

But at 2.375%, even not tax deductible, I'm not sure whether paying down the loan is that attractive if it is a 30-year loan. If you pay down a 30-year loan, you don't get a benefit for 30 years, and 2.375% isn't a great tax-free return on a 30-year bond. If you invest in Vanguard CA Long-Term Tax-Exempt instead, you earn 1.12% with a 6-year duration, so you take less interest-rate risk. If it is a 15-year loan, I would pay it down to the $750K deduction limit, but no further, as 2.375% risk-free is a good return on a 15-year bond, but the after-tax return once you start paying down deductible interest is no longer attractive.

If your lender will "recast" your loan, so that you can pay down the loan and pay off the remainder on the original schedule, this makes a paydown more attractive. Recasting a 30-year loan gives you a benefit every month for 30 years, which has about a 12-year duration (not 15 because the payments in later years have lower present value); if you can do this, I would pay it down to $750K. Recasting a 15-year loan has a 7-year duration.
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Re: Investing vs paying down mortgage

Post by mrsgoldilocks »

We are in the similar boat as you guys, but we are in our early 40s, and we just refi to 2.5%/30 years in Oct 2020 and since then was paying extra every month as if it's a 15 years mortgage. But recently, I was debating again if we should go pay down mortgage or we should invest, and we finally decided to invest the extra payment every month (auto-invest). The reasons being:

1) it is unlikely the mutual fund will not come ahead of 2.5%. and it is probably not that easy to get another 2.5%/30 years again.
2) once money is put into your house as equity, it is not that easy to get it out. Yes, you can refi cash out, but it is costly and it's not going to be done quickly (like in a matter of couple days), we rather the money is on our account for easy access. Plus, when you cash out refi, technically, you can't deduct that mortgage interest unless you're using it towards improvement of the house. Say after 15 years, you paid off your house, and you want to access the equality to pay for kids college or to bridge you over from early retirement to the time you can get SS or 59.5 or 55 for the rule of 55, you cannot deduct the mortgage interest.
3) and as of today, we have enough liquid asset that is at least 2 times of our mortgage balance (not including our not-so-liquid asset, i.e. rentals), so for us, the risk of not being able to pay off our house by the time we retire, it's highly unlikely.

But I think everyone is diff. Given that you guys are still so young, and your mortgage is a big one, the opportunity cost of putting your money into the mortgage is a lot higher than us. If i were you, i will keep the mortgage and diligently invest the "extra" payment in auto pilot. I think in 15 years, > 95% chance according to history, you will be glad for the decision.
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Re: Investing vs paying down mortgage

Post by jcricket73 »

grabiner wrote: Sun Jun 13, 2021 11:22 pm If you are planning to hold some bond investments, and don't need the liquidity from investments, it is better to pay down a mortgage rather than invest in lower-yielding bonds. If you are planning to invest 100% in stocks, keeping the mortgage might be reasonable if that is consistent with your risk tolerance and allows you to hold even more in stocks. (And for stocks, comparing taxable equivalent yield is not fair, as much of the return from stocks is tax-deferred.)
(Bolded part mine)

I feel like this debate always comes down to two things: 1) How quickly can you pay off your mortgage and "get back to investing"; 2) How will you know what a sufficient amount of "liquidity from investments" is? You can't give a blanket answer without knowing these questions.

On #1 - if a 30/40-something-year-old person has $100k a year overall to invest (after expenses, taxes) with a $1.3M mortgage they're normally paying $30k/year PITI on, to pay off the mortgage aggressively it'll take then 10 years of diverting 100% of their investment funds. This seems like a pretty unbalanced investment strategy (all in on real estate) a bad risk/reward trade-off long-term and bad for liquidity.

OTOH, if you had the same $100k to invest and a $300k mortgage, you could divert 30% of it, pay off the mortgage in 10 years, and still be investing $70k/year into stocks, bonds, etc. This seems more balanced as a strategy.

On #2 - This feels entirely personal and dependent on how long you've been earning what you're earning, how many kids/big ticket items you have, your health, your spouse's income (or lack thereof), how soon you plan to move, etc. Paying off a house you plan to move out of in 2 years is kind of neither here nor there in terms of interest savings. Paying off a house and then taking a HELOC for liquidity is fine, but not substantially better than having a taxable brokerage account money invested according to your AA.

To me it's never just come down to "I think I can beat the interest rate of my mortgage" but the fact that where we live (VHCOL area) we can't pay the mortgage off in any short amount of time, how long we stay is pretty variable, we have other large expenses (and kids) and while my income is stable (rising for the last decade) I've always slept better with more money in brokerage + retirement accounts than I will with a "paid off house". But maybe I'll feel differently when I'm in my 60s or 70s and retired, and want to reduce the draw-rate from my accounts to sustain my lifestyle so that bear markets don't scare me as much.

But even then, maybe not. Depends on what the debt service means in terms of draw rate. If servicing the debt is 0.5% WR, maybe I don't care and I'm happy to let the mortgage at 2.5% continue. If it's higher, maybe we move to lower costs and don't take out a new mortgage. Either way, substantially different calculus than while working for 20+ more years.

PS. Yes I am aware that purely mathematically I should drop the bonds, but I'm already fluctuating between 80-90% stocks, so the bonds are mostly for rebalancing opportunities.

PPS. I decided that should I find myself in the equivalent as scenario 1 (that is, with $1-2M a year to invest) I would probably also mix/match between stocks and paying down mortgage, if I could really pay it off in 5 years without diverting more than 30-50% of available funds per year.
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Re: Investing vs paying down mortgage

Post by mervinj7 »

masonary wrote: Sat Jun 12, 2021 5:04 pm Thanks for the response. Our goal is to retire early, although we have not spent time on figuring out how much is enough. We save > 60% of post tax income (before the home purchase). We have decided to live in the HCOL area because we have family and friends here.

1. We are both in tech and I consider the income secure in the medium term.
2. We are maximizing retirements plans, this year we have put in the max possible amount back door roth with IRA(6k each), megaback door roth (only one of our employers allows it) and pre tax 401k.
3. I was thinking about real estate, but you are right that I already have a huge exposure with my current home. TBH, I do not know what the alternatives are and just going off on a vague idea that I need to diversify.
You're in good shape no matter what you decide. How large is your EF? I would invest all $400k in a taxable account since you are already maxed out on tax advantaged. Revisit recasting the mortgage in 5 years after you have kids.

One of the above posters responded that interest over $750k is not deductible. Note, there are maneuvers around that and it's somewhat more common in silicon valley. Since your $400k is in cash right now, it's one thing to consider. That said, I personally don't do this.

https://www.svb.com/blogs/mary-toomey/m ... st-expense
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