2.875% mortgage pay-off financially justifiable?

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dillrob
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2.875% mortgage pay-off financially justifiable?

Post by dillrob » Thu Jan 29, 2015 2:15 pm

I have 12 years remaining on a 2.875% fixed rate mortgage (15 year original term). I am in the 35% marginal AMT range and will likely remain there (or 32% marginal AMT range) for the next 10 years. I am on track with retirement savings and have sufficient emergency funds, so these are non-factors.

So, with current 10 year yields at 1.75% and not likely (though possible) to go materially lower, is there anyway to financially justify paying off this mortgage rather than investing the cash?

I doubt that the after-tax rate on a comparable bond investment will ever be significantly lower than the after-tax loan rate to make paying off the mortgage financially viable. On the contrary, bond yields are so low they will probably go up at some point in the near future rather than down.

As always, your thoughts are appreciated.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by randomguy » Thu Jan 29, 2015 2:33 pm

dillrob wrote:I have 12 years remaining on a 2.875% fixed rate mortgage (15 year original term). I am in the 35% marginal AMT range and will likely remain there (or 32% marginal AMT range) for the next 10 years. I am on track with retirement savings and have sufficient emergency funds, so these are non-factors.

So, with current 10 year yields at 1.75% and not likely (though possible) to go materially lower, is there anyway to financially justify paying off this mortgage rather than investing the cash?

I doubt that the after-tax rate on a comparable bond investment will ever be significantly lower than the after-tax loan rate to make paying off the mortgage financially viable. On the contrary, bond yields are so low they will probably go up at some point in the near future rather than down.

As always, your thoughts are appreciated.
No way to justify it financially. You can justify it if you have a fear of debt.

DTSC
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Re: 2.875% mortgage pay-off financially justifiable?

Post by DTSC » Thu Jan 29, 2015 2:36 pm

I paid off a 3.25% mortgage early. Sure, you *might* make more money investing the money in stocks, but you might not. Why borrow and pay any amount of interest if you don't have to?

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Re: 2.875% mortgage pay-off financially justifiable?

Post by jbdiver » Thu Jan 29, 2015 2:45 pm

I'm currently refinancing and moving from a 30-year to a 15-year fixed mortgage at the same rate as yours. I considered paying off my mortgage as well. I figured that it was likely my funds would achieve as good a return, if not better, in the market versus my home. Regardless, I like the liquidity of the market.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by BrandonBogle » Thu Jan 29, 2015 2:55 pm

In my situation, I have 26 years left at 2.875% on the first mortgage, and a HELOC currently at 2.75 (last year's remodel). Both could be wiped out completely with my taxable accounts, but I am in no rush to pay off the first mortgage.

That said, financially speaking, you sound like you are further along and secure than me. Including adding to my retirement savings, living life, and enjoying life, I do have a small surplus monthly. Small enough though that it gets split between muni funds and stuff I fancy (gear, travel, gifts to others, etc.), but not enough to be thinking of a "better use" for the funds. You sound like you have that covered all this covered and still have a surplus. In that scenario, I could see the thought of paying down the mortgage, but I would still would only do it if it was because you have a fear of the debt. Otherwise, continue just investing or spending it as you see fit. Either way, I don't think you can be "wrong"!

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hand
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Re: 2.875% mortgage pay-off financially justifiable?

Post by hand » Thu Jan 29, 2015 2:55 pm

Tenuous financial justifications as follows:

1) You expect or fear deflation during the term of the mortgage
2) Asset protection
3) There are costs / risks to having a mortgage (paperwork, extra tax prep, risk of mortgage payment screw-up, hassle of mortgage servicer changes)
4) Cash used to pay off house can't /won't be spent on lifestyle instead

I think of something I'll keep while too poor to pay off, and while I am still actively growing my wealth, when I get to a point where I have "enough," I'll pay off to simplify my life even though it will likely cost me a couple dollars of returns.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by sls239 » Thu Jan 29, 2015 3:00 pm

If paying down the mortgage allows you to take more risk in other parts of your portfolio, then there is your justification.

Since many people want to reduce risk as they get older, paying down the mortgage could also substitute for that.

Also you can also get closer to justifying it if the duration of your mortgage isn't actually going to be 12 years, say because you'll be moving in 5 years.

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JamesSFO
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Re: 2.875% mortgage pay-off financially justifiable?

Post by JamesSFO » Thu Jan 29, 2015 3:01 pm

Overall likelihood of regretting paying off the mortgage early is low; psychological/emotional/behavioral satisfaction is high. Financial results seem to be neutral to ok.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by jchris » Thu Jan 29, 2015 3:14 pm

I just refinanced my loan to a 15 year note with that exact rate (it was previously at 4.5%). I could have paid it off instead, and seriously considered it, but when I looked at the numbers in detail it just didn't seem to make sense financially. Over the life of the note, you have to expect the market return to be superior to that rate, unless we have a very unusual situation over the next decade or so.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by AWH_CPA » Thu Jan 29, 2015 3:26 pm

On this one I like Dave Ramsey's answer the best. If you owned the house debt free, would you pull money out and stick it in the market? If you would then keep the mortgage. If you wouldn't then pay it off. It is the exact same thing just in reverse.

I'm in the same boat as you with a 2.875% fixed for 30 years (just started year 3). Currently our budget doesn't justify paying down the debt as we are already pretty tight. Moved from two incomes to one last year with the birth of our first. But as I get raises over the next 10 years our plan is to add 1/3 of the raise to spending, 1/3 to savings and 1/3 to the mortgage. This seems like a good compromise to me.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Watty » Thu Jan 29, 2015 3:35 pm

is there anyway to financially justify paying off this mortgage rather than investing the cash?
A couple of benefits in paying it off;

1) It improves your monthly cash flow.

2) If you keep 6 months expenses in an emergency fund, then you can reduce the size of your emergency fund because your expenses are lower.

3) It reduces the sequence of returns risk. You can likely expect to have a couple of bad investing years in the next ten years. If you happen to have just a 10% decline the first year, then you will have a real hard time catching up. Greatly oversimplified, but if you owe $100,000 and you are going to pay $10K a year, then if you have a 10% decline the first year you would only have $80,000 left (100K -10K -10%(10K) ) to pay of the remaining $90K balance.

4) If you invest the money with anywhere near a “your age in bonds” asset allocation then actually beating the mortgage rate after taxes might be harder than it sounds.

5) In some states your home equity may have some protection if you get sued.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by TomTX » Thu Jan 29, 2015 3:39 pm

AWH_CPA wrote:On this one I like Dave Ramsey's answer the best. If you owned the house debt free, would you pull money out and stick it in the market? If you would then keep the mortgage. If you wouldn't then pay it off. It is the exact same thing just in reverse.
For a no-cost, no hassle, non-callable loan? Absolutely.

...but I'm sitting @ 2.5%

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Re: 2.875% mortgage pay-off financially justifiable?

Post by AWH_CPA » Thu Jan 29, 2015 4:19 pm

TomTX wrote:
AWH_CPA wrote:On this one I like Dave Ramsey's answer the best. If you owned the house debt free, would you pull money out and stick it in the market? If you would then keep the mortgage. If you wouldn't then pay it off. It is the exact same thing just in reverse.
For a no-cost, no hassle, non-callable loan? Absolutely.

...but I'm sitting @ 2.5%

Then I would venture to say that debt does not scare you. Which is fine for you. For someone else, they might be risk adverse and prefer the house paid off.

Shredder
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Re: 2.875% mortgage pay-off financially justifiable?

Post by Shredder » Thu Jan 29, 2015 5:30 pm

If it were me i'd pay it off. I am debt averse :)

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Re: 2.875% mortgage pay-off financially justifiable?

Post by riverguy » Thu Jan 29, 2015 5:38 pm

Rates not likely to go lower? Just wait. US yields are on their way to other developed countries yields. 10 year going to 1%.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Downtown » Thu Jan 29, 2015 7:53 pm

We have the exact same rate on our 30 yr mortgage, but plan to pay it off over the next 23 months (we'll both be 52 yrs old). It's a little painful every month, but then we'll be done with it quickly. We now have the end in sight, which has become really motivating. To make it even more tangible, we put beads in a vase representing the original balance (1 bead = $1k), then manually pull the beads out every month as we aggressively pay the balance down. I'm sure we're violating some financial recommendations/guidelines others may have given such a low rate, but it still feels good!

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Re: 2.875% mortgage pay-off financially justifiable?

Post by mrboast » Thu Jan 29, 2015 8:12 pm

We are entering the realm of psychology. Some of these folks would pay off a negative interest rate mortgage just for a self pat on the back. A paid for house doesn't get you much besides more monthly cash flow, which of course sacrifices liquidity. To me, at the costs of a silly low rate, liquidity is better than owning a hard asset, which involves great difficulty and costs to monetize. Yay, you own your home debt free - the government will still come take it of you don't pay them each year a percentage of its value...ergo it is really not yours anyway. Vanguard Balanced Index Fund is up 7.21% annualized the last 10 years which covers the worst financial crises we've had in generations. If your end result is more money, the choice with the much higher probability, with added risk, of satisfying that is to keep the mortgage. If you are the emotional type and will get some sentimental satisfaction out of owning your home debt free, then pay off the mortgage; for me, I like my odds of beating 2.875% over the long term (a little less effective rate for you probably) and also like the options that liquidity gives me..and you did ask for a "financial" opinion.

You don't have to look any further than the post above mine for example numero uno of undue emotional influence..."painful", "feels", "beads", "vase", "end in sight"

This is probably a case where you won't regret either decision.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by grabiner » Thu Jan 29, 2015 10:34 pm

Can you pay it all off at once? If you can, then you get a duration of six years on your 2.875% tax-deductible interest (since you eliminate it payments 0-12 years in the future, which is as good as the after-tax return on a portfolio of six-year municipal bonds, and has no risk. If you can only pay it down, then you get a duration of 11 years, which is less attractive.
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Re: 2.875% mortgage pay-off financially justifiable?

Post by Pizzasteve510 » Fri Jan 30, 2015 12:50 am

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sketchy9
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Re: 2.875% mortgage pay-off financially justifiable?

Post by sketchy9 » Fri Jan 30, 2015 3:00 am

I know it's not exactly the same because the mortgage is secured to a piece of real property, but I just paid off the remaining student loan that I had ($125k) @ 2.23%. On paper it's not really a great decision. But, I did it for the following reasons:

1. Monthly cash flow. I will now be able to save ~$1k/month in loan servicing for the next 20 years. It's made my expense:paycheck ratio lower which is always a good thing.
2. Student loans are non-dischargable in bankruptcy unlike mortgages, so this albatross was going to follow me either to the pay-off date or to the grave. Again, not entirely comparable to a mortgage, but in the absence of this feature, a somewhat less compelling argument to pay it off.
3. Psychology. It is a nice feeling to be free of debt. No two ways about it.

Ultimately I think the Dave Ramsey approach is the best. Assuming your house were paid off, would you take out an equivalent loan on its equity and use that money to invest? Your answer to that question will dictate what you should do.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Buffetologist » Fri Jan 30, 2015 5:11 am

I don't mix emotions and math. Maybe I'm part Vulcan.

Think of every payment over the next 12 years as it's own bond. With your mortgage, you currently have a short position on a riskless bond portfolio with an average duration of 6 years and a yield of 2.875%. When making partial prepayments, you are forced to buy the longer duration bonds first since prepayments don't reduce your payments.

When doing your investment portfolio, consider prepayments to the mortgage as the repurchasing of these bonds.

Just put your allocation of bonds toward the mortgage, as long as alternatives are not any better. Right now EE bonds are better but you can only buy 10K per SSN. For my tax bracket the effective tax rate on prepaying the mortgage is 39.6%+1.188% from limitations on mortgage deduction. Therefore my 2.75% 8 years remaining mortgage really costs me 1.63% after taxes for an average duration of 4 years. Assuming that the EE bonds will mature when I'm in retirement, and my tax rate will be 28%, my after-tax yield on EE bonds held for 20 years would be ((1.72)^(1/20)-1)*100 = 2.75%. Last year I noticed that Vanguard Intermediate Term Tax Free Investment grade Admiral was yielding 2.15% for me after taxes. I bought that rather than prepaying my mortgage. I knew that I was taking more credit risk but I felt compensated for it. Today I calculate my after tax yield on that fund to be 1.48%. If it were not for the 12% Massachusetts tax on short-term capital gains, it would make sense for me to sell the muni fund and put it toward my mortgage. Once my year is up shortly, I will reevaluate.

Based on what you said, I calculate your after-tax yield on mortgage prepayments to be 2.875*(1-35%) =1.87%. Once you've maxed out on EE bonds, that's a pretty good yield for a riskless bond investment. You can take a little more risk and get something a little less than the 2.12% that Vanguard Long-Term tax exempt Admiral is yielding depending on your state tax rate. If I could only afford small prepayments so that my prepayments are really long duration bond investments, I might consider the Vanguard Long-Term tax exempt Admiral to be an alternative, but if I could afford to pay the whole thing as part of my bond allocation, I think I would prepay the mortgage if I had to do it today.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by awval999 » Fri Jan 30, 2015 5:51 am

As other posters have made clear, financially it is NOT justifiable. But, I do bet it feels good not to have a mortgage anymore.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Buffetologist » Fri Jan 30, 2015 6:27 am

awval999 wrote:As other posters have made clear, financially it is NOT justifiable. But, I do bet it feels good not to have a mortgage anymore.
I think I made the case that it could be justifiable, feelings and emotions aside.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by dillrob » Fri Jan 30, 2015 9:18 am

Thanks for the input and advice. Emotions aside, the general consensus is that it makes more financial sense not to pay off the mortgage at this point since there are equivalent (from a risk perspective) higher yielding alternatives.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Triple digit golfer » Fri Jan 30, 2015 10:05 am

Of course it's financially justifiable. You'd be getting a guaranteed 2.875% return and you'd own your home outright.

Are there better alternatives? Possibly. But additional potential return does not come without risk.

To say it's not financially justifiable is the same as telling somebody with money in bonds as part of a long-term allocation that investing in bonds is not financially justifiable because stocks have higher expected returns.

To the guy who is sitting at 70/30 to retire in 15 years, with $700,000 in stocks and $300,000 in bonds. Is investing in bonds financially justifiable? Of course. Stocks have a higher expected return, but maybe after evaluating his willingness, need, and ability to take risk, he's decided that $300,000 in bonds is right for him. Just like paying off your mortgage may be right for you.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Artsdoctor » Fri Jan 30, 2015 10:31 am

That interest rate is very attractive, and I suspect that you're itemizing which makes it even lower.

You mentioned "investing in cash." Do you have the mortgage balance in cash? Or would you have to generate a capital gain to pay off the mortgage?

How secure is your job? How much of an "emergency cushion" do you and your family need? Cash may not be generating much income, but at least it's liquid. Your home is an illiquid asset and once you pay it off, I wouldn't count on "tapping" it for liquidity (HELOCs can be canceled, you won't qualify for a second mortgage if you're unemployed, etc.).

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Re: 2.875% mortgage pay-off financially justifiable?

Post by jnet2000 » Fri Jan 30, 2015 3:26 pm

dillrob wrote:I have 12 years remaining on a 2.875% fixed rate mortgage (15 year original term). I am in the 35% marginal AMT range and will likely remain there (or 32% marginal AMT range) for the next 10 years. I am on track with retirement savings and have sufficient emergency funds, so these are non-factors.

So, with current 10 year yields at 1.75% and not likely (though possible) to go materially lower, is there anyway to financially justify paying off this mortgage rather than investing the cash?

I doubt that the after-tax rate on a comparable bond investment will ever be significantly lower than the after-tax loan rate to make paying off the mortgage financially viable. On the contrary, bond yields are so low they will probably go up at some point in the near future rather than down.

As always, your thoughts are appreciated.
Coming from someone in the 33% percent tax bracket with a paid for house, No. You are looking at this from a mathematical standpoint and it doesn't make sense.

It didn't make sense for me either. But I did i paid off my mortgage and I have no regrets. I sleep better at night :beer and the only regret I have is not doing it sooner.
"You really don't need leverage in this world much. If you're smart, you're going to make a lot of money without borrowing" Warren Buffet

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Re: 2.875% mortgage pay-off financially justifiable?

Post by kingsnake » Fri Jan 30, 2015 5:16 pm

I still owe 370,000 dollars with 12 years left at 2.75%, with no plans to pay it off early since I'm in the 39.5% marginal bracket, I'll take my chances investing in the market over the next 12 years. My house is my only debt.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by barnaclebob » Fri Jan 30, 2015 5:18 pm

Im paying off a mortgage of the same rate early. I also invest in taxable accounts. I just like the idea of paying it off early and diversifying where my money goes. My interest is so low that we still take the standard deduction.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by skibum » Sat Jan 31, 2015 1:58 am

So many ways to consider the financial factors, but ultimately an emotional decision.

Comparing the improved cash flow w/o mortgage to reduced SWR for portfolio less mortgage balance provides an interesting result (although heavily distorted by the relative length of mortgage to SRW duration of course)

10 yrs and $100k remaining on a 15 yr note at 2.625%, payment of $1,000/mo. Reducing savings balance by $100k to payoff mortgage at retirement would reduce mortgage expense by $12k/yr, and reduce SWR by $3k-$4k/yr at 3%-4% sustained withdrawal rate. Net cash flow increase of $8k-$9k/yr for the next 10 years for typical SWR range. Psychological benefit of retirement w/o mortgage, and reduced sequence of return risk. Down side is loss of liquidity, opportunity for higher returns, and distorted duration to compare cash flow of 10 year mortgage to 30 year SWR.

Although this is not an apples to apples comparison, the extra cash flow in early retirement looks attractive.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Hunky-dory » Sat Jan 31, 2015 10:52 am

I think it really depends on your personal situation. I have read a number of posts in this forum on this topic and thought I would share my decision making process for what it is worth. Last year I made a decision to direct some money each month to paying off a 3.5% mortgage. For me, the driving factors in that decision were (1) I have a high paying job that does not come with a great deal of job security (if another financial crash occurs there is a very good chance I would need to take a significant pay cut or deal with an extended period of unemployment - in both instances the ability to refinance my mortgage could be very helpful) and (2) a belief that the market may be due for a correction in the near term (a much less important factor because if I could predict market movements I would quit my day job).

I think the security of your primary income stream is an important factor in the decision. You said you were likely to have a high paying job for the next 10 years. In my mind, if your job is very secure and you are not nearing your preferred retirement age there is really no reason to pay off your mortgage early because there is little risk that you will need to liquidate your investments at a market bottom in order to cover your basic needs. However, I think if your job is less secure and you are already maxing out tax preferred accounts than it may make more sense to pay off the mortgage and lower your exposure to risk. When the next financial crisis comes, I want to be in a position to be buying stocks or at least holding what I have instead of selling so paying off my mortgage early made sense to me given my employment situation, my opinion of current stock market prices and my time horizon. It is a nice question for you to be in a position to deal with and you should feel good about whatever decision you make.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by DTSC » Sat Jan 31, 2015 2:29 pm

I think maybe some of us are suffering from recency bias. How many people wanted to take out a home equity loan to invest in stocks back in 2009? How many want to do that after 5 years of the stock market going up?

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Re: 2.875% mortgage pay-off financially justifiable?

Post by basspond » Sun Feb 01, 2015 7:51 am

The best decision you made was getting a 15 mortgage. Either way is fine but the longer you are in a 15 year mortgage the less interest you will be saving. The older you are should affect your decision to pay it off early too.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Leemiller » Sun Feb 01, 2015 1:25 pm

rkc312 wrote:I think it really depends on your personal situation. I have read a number of posts in this forum on this topic and thought I would share my decision making process for what it is worth. Last year I made a decision to direct some money each month to paying off a 3.5% mortgage. For me, the driving factors in that decision were (1) I have a high paying job that does not come with a great deal of job security (if another financial crash occurs there is a very good chance I would need to take a significant pay cut or deal with an extended period of unemployment - in both instances the ability to refinance my mortgage could be very helpful) and (2) a belief that the market may be due for a correction in the near term (a much less important factor because if I could predict market movements I would quit my day job).

I think the security of your primary income stream is an important factor in the decision. You said you were likely to have a high paying job for the next 10 years. In my mind, if your job is very secure and you are not nearing your preferred retirement age there is really no reason to pay off your mortgage early because there is little risk that you will need to liquidate your investments at a market bottom in order to cover your basic needs. However, I think if your job is less secure and you are already maxing out tax preferred accounts than it may make more sense to pay off the mortgage and lower your exposure to risk. When the next financial crisis comes, I want to be in a position to be buying stocks or at least holding what I have instead of selling so paying off my mortgage early made sense to me given my employment situation, my opinion of current stock market prices and my time horizon. It is a nice question for you to be in a position to deal with and you should feel good about whatever decision you make.
I don't think you can refinance if you're unemployed. Also, HELOCs got frozen in the last crisis.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by vencat » Sun Feb 01, 2015 2:11 pm

I was in a similar situation. 2.875% for 10 years. Could have paid off long ago. Finally did last month with funds from my Limited Tax Exempt fund. Wife and I feel good about it.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by malabargold » Sun Feb 01, 2015 11:08 pm

If you intend to place the money you would use to pay off the mortgage in bonds only,
then yes, pay off the loan.
Its a great time to be a borrower, consequently it is not an auspicious
time to be a lender.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by epicahab » Mon Feb 06, 2017 4:15 pm

DTSC wrote:I paid off a 3.25% mortgage early. Sure, you *might* make more money investing the money in stocks, but you might not. Why borrow and pay any amount of interest if you don't have to?
Ding ding ding, we have a winner.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Kevin M » Mon Feb 06, 2017 4:46 pm

grabiner wrote:Can you pay it all off at once? If you can, then you get a duration of six years on your 2.875% tax-deductible interest (since you eliminate it payments 0-12 years in the future, which is as good as the after-tax return on a portfolio of six-year municipal bonds, and has no risk. If you can only pay it down, then you get a duration of 11 years, which is less attractive.
Is this calc close enough?

At 35% tax after-tax yield is 1.87%. I see 7-year "highest grade" muni at Vanguard with yield 2.28% (Find CDs and bonds). Assuming coupon = yield, modified duration = 6.44, so in the ballpark, assuming loan paid off now. So you earn about 40 basis points more by taking a little credit risk and a little more term risk with the muni than by paying off the loan. Pretty close to a wash I'd say.

Assuming pay down instead of pay off, I see 10-year highest grade muni at 2.87%, so 100 bps more than loan after-tax rate. So perhaps more attractive to buy this muni rather than make an extra payment on the loan principal, assuming you will not pay it off early?

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Re: 2.875% mortgage pay-off financially justifiable?

Post by supersharpie » Mon Feb 06, 2017 4:50 pm

epicahab wrote:
DTSC wrote:I paid off a 3.25% mortgage early. Sure, you *might* make more money investing the money in stocks, but you might not. Why borrow and pay any amount of interest if you don't have to?
Ding ding ding, we have a winner.
However, chances are very good that you will make far more money by investing vs paying off a loan w/an interest rate barely above inflation. If you are an extremely risk averse, conservative investor then by all means may it off. Nonetheless, it is far from a "no brainer" for most folks.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by toto238 » Mon Feb 06, 2017 5:16 pm

From a pure NAV, IRR, mathematical financial perspective, there is no way to justify using the extra cash to pay off the mortgage.

Some people find peace of mind having less debt.

Me personally, it stresses me out to tie down my money in a house that I would have to sell if I needed it in the case of an emergency. If I invest my excess cash I can always liquidate it in case of emergency.

Debt is a tool, nothing more. It's a tool that enables me to maintain liquidity sufficient to deal with most things life may throw my way.

I personally have never understood the appeal of reducing debt just so you have a lower number on a spreadsheet despite it being the mathematically incorrect choice and reducing one's liquidity.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Kevin M » Mon Feb 06, 2017 5:19 pm

supersharpie wrote: However, chances are very good that you will make far more money by investing vs paying off a loan w/an interest rate barely above inflation.
Chances also are very good that you'll make more money in stocks than in bonds (or other fixed income), yet most of us still include fixed income in our portfolios. It just doesn't make sense to compare a risk-free return to a risky expected return.

You could also say that chances are very good that if you borrow at 2% to invest in stocks that you'll make more money than if you don't, yet I doubt most Bogleheads borrow specifically to invest in stocks. Of course many Bogleheads are essentially doing this (or worse) by buying stocks (and bonds) while carrying mortgage debt.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Kevin M » Mon Feb 06, 2017 5:29 pm

toto238 wrote:From a pure NAV, IRR, mathematical financial perspective, there is no way to justify using the extra cash to pay off the mortgage.
This is just patently false without providing some context.

For your IRR calc, you must select an alternative use of the money that has the same risk as not paying off the loan, which is basically the term risk of the loan. As explained by grabiner, the duration of paying off the 12-year loan is about six years, so roughly the duration of a 7-year Treasury (no credit risk, only term risk, like the loan). Yield on 7-year Treasury is 2.19% (Daily Treasury Yield Curve Rates), which is 1.42% after 35% tax. The loan is 1.87% after tax, so paying off the loan provides a superior, risk-equivalent return.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by inbox788 » Mon Feb 06, 2017 5:38 pm

dillrob wrote:Thanks for the input and advice. Emotions aside, the general consensus is that it makes more financial sense not to pay off the mortgage at this point since there are equivalent (from a risk perspective) higher yielding alternatives.
What is you AA? What are you investing that's higher or lower yield?

It's very justifiable if you have bonds that pay less than that (i.e. I wouldn't borrow at 3% to lend it out at 2%). It's also very justifiable to invest it in stocks and expect a higher return (borrow at 3% to maybe make 6%). As the rate goes up, it becomes less justifiable.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Nowizard » Mon Feb 06, 2017 5:47 pm

If my figures are correct, you would have to make 3.82 percent on your investments, not counting any state income tax you may be obligated to pay (2.785 + .33 X 2.875, your marginal tax rate), assuming your invested proceeds were in taxable accounts. That amount, minus the deduction from income tax, assuming you itemize, would be the risk. I would hope you would generate a higher return than that by at least a couple of percentage points annually over the next 12 years. The amount of the outstanding loan could be a factor if even a quite positive return generated relatively small amounts.

Having said that, we obtained significantly higher mortgages over the years than necessary and did invest the proceeds. We would have taken about as much as we could get when your age at 2.875%. Our approach resulted in significantly increased assets for us and was a substantial addition to what is a comfortable retirement today. Not for everyone, but the general advice of paying off mortgages as part of retirement planning is also not necessarily the best advice for those with either substantial assets or sustainable sources of retirement income such as SS and pensions in addition to IRA proceeds. This is likely to be a different approach than that recommended by most responders to your post.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by grabiner » Tue Feb 07, 2017 12:06 am

Kevin M wrote:
grabiner wrote:Can you pay it all off at once? If you can, then you get a duration of six years on your 2.875% tax-deductible interest (since you eliminate it payments 0-12 years in the future, which is as good as the after-tax return on a portfolio of six-year municipal bonds, and has no risk. If you can only pay it down, then you get a duration of 11 years, which is less attractive.
Is this calc close enough?

At 35% tax after-tax yield is 1.87%. I see 7-year "highest grade" muni at Vanguard with yield 2.28% (Find CDs and bonds). Assuming coupon = yield, modified duration = 6.44, so in the ballpark, assuming loan paid off now. So you earn about 40 basis points more by taking a little credit risk and a little more term risk with the muni than by paying off the loan. Pretty close to a wash I'd say.

Assuming pay down instead of pay off, I see 10-year highest grade muni at 2.87%, so 100 bps more than loan after-tax rate. So perhaps more attractive to buy this muni rather than make an extra payment on the loan principal, assuming you will not pay it off early?
That's about how I see it. I would subtract 0.12% from muni yields because you probably won't hold individual bonds; you can invest in a diversified muni portfolio at 0.12% expenses through Vanguard's Admiral shares. A mixture of Vanguard Intermediate-Term Tax-Exempt and Vanguard Long-Term Tax-Exempt with a six-year duration would yield 2.44%; this is higher than the example yield above because Vanguard's funds hold mostly AA-rated rather than AAA-rated bonds.

I am in exactly the same situation. My rate is 2.625%, also with 12 years left, but my tax bracket is only 28%, so my after-tax rate is 1.89%, essentially the same as the OP's. And by the same logic, I would not pay off my mortgage with the current interest rates, even if I could do it with no tax cost. (I can't pay it off now anyway without a large tax bill, as I have capital gains on everything in my taxable account.)
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Re: 2.875% mortgage pay-off financially justifiable?

Post by Nick341981 » Tue Feb 07, 2017 12:16 am

AWH_CPA wrote:On this one I like Dave Ramsey's answer the best. If you owned the house debt free, would you pull money out and stick it in the market? If you would then keep the mortgage. If you wouldn't then pay it off. It is the exact same thing just in reverse.

I'm in the same boat as you with a 2.875% fixed for 30 years (just started year 3). Currently our budget doesn't justify paying down the debt as we are already pretty tight. Moved from two incomes to one last year with the birth of our first. But as I get raises over the next 10 years our plan is to add 1/3 of the raise to spending, 1/3 to savings and 1/3 to the mortgage. This seems like a good compromise to me.
At 2.8% I would borrow as much money as the bank would loan me and hopefully at a 30 year term. It's an odds game of course but I really like my odds of coming out ahead in that situation

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Earl Lemongrab » Tue Feb 07, 2017 11:12 am

epicahab wrote:
DTSC wrote:I paid off a 3.25% mortgage early. Sure, you *might* make more money investing the money in stocks, but you might not. Why borrow and pay any amount of interest if you don't have to?
Ding ding ding, we have a winner.
Not in my book. Mortgage rates under discussion are cheap leverage and likely to reap benefits down the line.
This week's fortune cookie: "Your financial life will be secure and beneficial." So I got that going for me, which is nice.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by inbox788 » Tue Feb 07, 2017 12:30 pm

Earl Lemongrab wrote:
epicahab wrote:
DTSC wrote:I paid off a 3.25% mortgage early. Sure, you *might* make more money investing the money in stocks, but you might not. Why borrow and pay any amount of interest if you don't have to?
Ding ding ding, we have a winner.
Not in my book. Mortgage rates under discussion are cheap leverage and likely to reap benefits down the line.
Are you inadvertently changing your desired AA?

An increasing portion of my AA is going towards bonds, which in the last few years have returned 2% or less with varying degrees of tax consequences down the road. My "investment" in mortgage has returned more, and I will have future liquid cash flow.

It's a different question using the mortgage monies to buy bonds or stocks. And there's always the whatif question; what if you didn't have a mortgage. Would you take out a 2-3% long dated mortgage to invest in stocks, bonds or other?

viewtopic.php?f=1&t=209968&newpost=3228025#p3221628
Just came across this as a more sophisticated comparison to bonds including duration risk, so you may want to take into account longer term bond rates and decide the other way. Also, don't forget tax effects and adjustments.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Kevin M » Tue Feb 07, 2017 2:10 pm

Nick341981 wrote: At 2.8% I would borrow as much money as the bank would loan me and hopefully at a 30 year term. It's an odds game of course but I really like my odds of coming out ahead in that situation
Does this mean your AA is 100% stocks, and that you'd like an even higher allocation to stocks?

Yield on the 20-year Treasury is just about 2.8%, so if you hold any bonds with less term risk, then selling them to buy more stocks is comparable to borrowing money at 2.8% or less (risk adjusted) to buy stocks. Either way you effectively lower your allocation to bonds and increase your allocation to stocks.

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Re: 2.875% mortgage pay-off financially justifiable?

Post by Earl Lemongrab » Tue Feb 07, 2017 2:11 pm

inbox788 wrote:
Earl Lemongrab wrote:Not in my book. Mortgage rates under discussion are cheap leverage and likely to reap benefits down the line.
It's a different question using the mortgage monies to buy bonds or stocks. And there's always the whatif question; what if you didn't have a mortgage. Would you take out a 2-3% long dated mortgage to invest in stocks, bonds or other?
No only would I, but I did. Well, not as long-dated as I would have liked, it would have been even better as a 15 or 30 year loan. I would certainly consider another low-rate loan for investing if the opportunity were right.

I am not afraid of debt, or loans. At all.
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