Paying off mortgage @ 2.875% or buying I-bond or other bond

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NorthernVa
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Paying off mortgage @ 2.875% or buying I-bond or other bond

Post by NorthernVa »

I have a 15yr fixed mortgage at 2.875%. I am debating whether to use the extra cash to pay 20% of the mortgage. Doing so would allow me to pay off my mortgage in 10 yrs. My retirement account is fully funded and I have savings (I-bond, stock and bond index funds) in taxable account. My job is very secure, but I wouldn't expect too much of an increase in the future if I stay here. I am in the accumulation phase. My tax bracket is 25% federal and 5% state.

1)With I-bond currently yielding less than 2%, the cash is better used to pay off the mortgage even after considering the tax benefit. Of course, I don't know about the future inflation. I know that the I-bond limit is 10k per year for each SSN, and I hold a number of I-bonds. I am just wondering what other ways to get a guaranteed return of 2% besides I-bond.

2) If I am not using this money to pay off my mortgage debt, I'd like to put it separately in an account (taxable) and invest it in the total bond market fund.

I've seen my saving rate dropping significantly after purchasing the house. The insurance, repair, maintenance, and utility all add up. So I may not be able to save a lot down the road. Also I don't intend to pay it off earlier than 10 yrs.

What's your suggestions? 1 or 2 ? Or it doesn't matter in the long run?

Thanks!
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tfb
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by tfb »

I would sell existing bond index funds from taxable account and use the money to pay down the mortgage. Still keep buying I bonds to the maximum allowed. Sell more from bond index funds from taxable account if you don't have enough cashflow to buy I bonds.
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NYBoglehead
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by NYBoglehead »

I'd put it towards paying the mortgage down quicker. You can always stop making the extra payments at any time.
runnergirl
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by runnergirl »

I also have a 2.875% 15 year mortgage. Regarding TFB's recommendation to contribute the max to I bonds (which we are currently doing) and then selling off other bond funds to pay off the mortgage, does the recommendation apply to contributions to TIPS (in 401K) and G Fund (in TSP)? The TIPS/G Fund are about 30% of our portfolio. No bond funds in taxable.
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Cosmo
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by Cosmo »

NorthernVa wrote: Of course, I don't know about the future inflation.

I've seen my saving rate dropping significantly after purchasing the house. The insurance, repair, maintenance, and utility all add up. So I may not be able to save a lot down the road. Also I don't intend to pay it off earlier than 10 yrs.

This is interesting. An ultra-low 2.85% 15 year mortgage and the general consensus thus far is to pay it off. To me, you have to be making a big assumption to go this route. And that is interest rates are going to stay super low. Really? for the next 15 years?

Worried about inflation? A mortgage is a good inflation hedge -even a 15 year mortgage. Even with modest inflation (last year, the six month I-bond yield was 4.65% annualized for a six month period), you are likely to come out ahead with I-bonds. You have a very low rate. Keep the mortgage!

Worried about unexpected repairs and maintenance? Stay liquid and keep the mortgage!

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NorCalDad
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by NorCalDad »

Agree with Cosmo. This seems like a very risk averse, conservative approach with a 2.875 interest rate. At the very least go with tfb's suggestion. How many years do you have left in the accumulation phase?
letsgobobby
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by letsgobobby »

agree with the others, don't pay it off.
Default User BR
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by Default User BR »

As I have stated before, low-rate fixed mortgages are good hedges against possible future interest rate and inflation increases. I would not pay it off early.


Brian
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by gmoa »

We just got a 3.375% rate 30-yr mortgage -- will probably pay off a little faster in the beginning ONLY because of PMI (and maybe even not then; haven't run the calcs yet). After we have 20% equity, it's going to be minimum payments on that bad boy from there on out. I've got to imagine we can earn a better return on investments in the market than 3.375% over the upcoming 30-yr period. We are also in our twenties, so we have a significantly higher risk tolerance than say someone in their fifties.

My attempt to help contribute an answer with an anecdote...
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NorthernVa
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by NorthernVa »

Thank you for all your replies!

I've read some discussions on this topic before I got a mortgage myself. Then I've been thinking all the time about whether or not to send another big check to the mortgage company. I chose to pay only 20% at the closing (about 7-8 weeks ago), so I'll have more time to think about it. Right now I only made one regular payment so far. But I have money sitting in the short term tax exempt bond that could be used to pay another 20% of the mortgage. I am not comfortable to allocate this money into my permanent portfolio, i.e. buy stock index fund in the taxable account and exchange the stock fund to bond in the retirement account. If I do that then the money becomes less liquid.

Like TFB suggested, I'll make sure that I have money to buy the maximum amount of I-bond each year.

The 15 yr mortgage will be paid off prior to my retirement.
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by tfb »

runnergirl wrote:I also have a 2.875% 15 year mortgage. Regarding TFB's recommendation to contribute the max to I bonds (which we are currently doing) and then selling off other bond funds to pay off the mortgage, does the recommendation apply to contributions to TIPS (in 401K) and G Fund (in TSP)? The TIPS/G Fund are about 30% of our portfolio. No bond funds in taxable.
I would not reduce contributions to 401k or TSP. If you are adding new money to stock funds in taxable, I would exchange G fund in TSP to stock funds and use new money to pay down mortgage. G fund pays 5-year Treasury rate, which is 0.65% currently. That's less than bank savings account.
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tfb
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by tfb »

Default User BR wrote:As I have stated before, low-rate fixed mortgages are good hedges against possible future interest rate and inflation increases. I would not pay it off early.
The hedge is not free. For every year you hold out, you are paying a rate difference. By the time interest rates finally increase (if that happens), you are already way behind. The hedge also only lasts until you move, not full 30 years for someone having a 30-year mortgage. I gave this example in a comment to my write-up about this:

Say higher rates and/or inflation happens in year 8 and you are moving in year 10, you pay the price for 8 years and you only get to enjoy the hedge for 2 years.

Pay Down Mortgage vs Investing In Bonds

To all who say don't pay off, what do you do with the money after buying I bonds?
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Default User BR
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by Default User BR »

tfb wrote:The hedge is not free. For every year you hold out, you are paying a rate difference. By the time interest rates finally increase (if that happens), you are already way behind.
You're making the assumption that the money that would pay it off is invested in low-returning assets. The other thing a mortgage provides is cheap, stable leverage. The expected return for a well-diversified portfolio will be greater than the return guaranteed by the payoff. Whether the extra risk is worth it is a factor to consider.

I would not pass on the opportunity in this case.


Brian
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by tfb »

Default User BR wrote:You're making the assumption that the money that would pay it off is invested in low-returning assets. The other thing a mortgage provides is cheap, stable leverage. The expected return for a well-diversified portfolio will be greater than the return guaranteed by the payoff. Whether the extra risk is worth it is a factor to consider.
The OP gave us that constraint. It doesn't appear NorthernVa is interested in taking the extra risk.
NorthernVa wrote:2) If I am not using this money to pay off my mortgage debt, I'd like to put it separately in an account (taxable) and invest it in the total bond market fund.
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haban01
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by haban01 »

Good Morning,

I'm in a similar debate. In my case, I'm going to send extra money to my wife's Roth IRA instead of paying that low rate 15 yr off. I have to believe that you would surely beat the 2.85% in say a TM Balanced fund over the next 15 years. Additionally, You have options and your fixed costs are structured.

Additionally, You may be getting a tax deduction, thus reducing the interest cost even more. :)
Eric | | "Stay the Course" | "Press on Regardless"
edawg
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by edawg »

NorthernVa wrote:Thank you for all your replies!

I've read some discussions on this topic before I got a mortgage myself. Then I've been thinking all the time about whether or not to send another big check to the mortgage company. I chose to pay only 20% at the closing (about 7-8 weeks ago), so I'll have more time to think about it. Right now I only made one regular payment so far. But I have money sitting in the short term tax exempt bond that could be used to pay another 20% of the mortgage. I am not comfortable to allocate this money into my permanent portfolio, i.e. buy stock index fund in the taxable account and exchange the stock fund to bond in the retirement account. If I do that then the money becomes less liquid.

Like TFB suggested, I'll make sure that I have money to buy the maximum amount of I-bond each year.

The 15 yr mortgage will be paid off prior to my retirement.
Risk and control are equally important in reaching a "comfortable" financial state. And from living both mortgage-free and now with a mortgage, control over cashflow is everything. Paying interest on principal to then risk it on interest rate decisions by someone in Washington D.C. or New York you don't control is not a recipe for comfortable living.

So my advice is to "recast" the mortgage with your lender if you can pay down at least 10% (or as much as you're comfortable putting in), but ONLY if you will take the resulting increase in your monthly cash flow and dollar cost average into either the mortgage or a bond fund of choice (whichever yield is higher at the time). This ensures the capital you put into the house "earns" 2.875% plus you have the cashflow to re-invest and increase overall return. And when (not if) interest rates rise a few years down the road, you'll have lower risk to your current principal assuming bond fund values generally drop as rates rise. Yes, some will say there's an opportunity cost of interest you may be able to earn on today's principal in other bond funds the long run, but that's a "bird in the bush" frankly. And at 70% or even 60% debt to equity in the house (assuming you put another 20% in), you should still get some tax benefit from the mortgage balance that remains. And you'll have lower risk, higher return on principal and greater control on liquidity (when you need it).
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by Default User BR »

tfb wrote:The OP gave us that constraint. It doesn't appear NorthernVa is interested in taking the extra risk.
Good point. Circumstances will vary. I could get 2.65% currently in a corporate stable-value, but the OP probably doesn't have that exact offering.

My general feeling is that taking the mortgage is great, as long as you don't treat it as part of your investing. That is, don't adjust your portfolio to buy more bonds (although that would have been a great deal over the past several years).


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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by grabiner »

NorthernVa wrote:I have a 15yr fixed mortgage at 2.875%. I am debating whether to use the extra cash to pay 20% of the mortgage. Doing so would allow me to pay off my mortgage in 10 yrs.
Wiki article link: Paying down loans versus investing

It's close, but I wouldn't recommend doing this specific payoff. With your federal tax rate, the effective return on paying down the mortgage is 2.16% (2.05% after state tax), and you won't get the cash benefit until years 10-15, so the effective duration of the mortgage payoff is 12 years. You could invest the money in Admiral shares of Long-Term Tax-Exempt and earn 2.24% (2.13% after state tax); the muni fund has a bit of credit risk but a shorter duration. In addition, you lose liquidity by paying down the mortgage. In addition, the cost of the mortgage might decrease if you move to a higher tax bracket.

If you might sell the house in 5 years, then the mortgage payment looks more attractive. Likewise, if you will be making extra payments on the mortgage in the future, so that you might pay it off faster than 10 years, it looks more attractive.

But if you want to pay off the mortgage for peace of mind, that certainly isn't wrong. You aren't wasting the opportunity to get tax-deferred savings since you are already maxing out your retirement account.
Wiki David Grabiner
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NorthernVa
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Re: Paying off mortgage @ 2.875% or buying I-bond or other b

Post by NorthernVa »

Well, I understand that this is a very personal decision that I have to make myself. There are enough debates on this subject already, and there are divided opinions about paying the mortgage early. Someone suggested that I could do a recast of my mortgage, so I've contacted my mortgage company, Wells Fargo. For $250.0 processing fee, they could do the modification of my monthly payment. A 30K principal payment would lead to roughly $200 reduction in monthly payment. Every 10K more would reduce $60.0 of the monthly payment.

As I said earlier, I have already maxed out my retirement account, Roth IRA, I-bond, HSA. I am not going to invest the money in stock market in my taxable account. So, the best choice for me would be:

1) recast my mortgage
2) buy the Admiral shares of Long-Term Tax-Exempt as grabiner suggested.

I have to admit that it's hard to write this big check to Wells Fargo ...

Thanks for all your input.
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