Pay down mortgage, or invest?

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mpowered
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Pay down mortgage, or invest?

Post by mpowered » Tue Dec 22, 2015 10:29 am

About a year ago, my wife and I moved into a substantially larger home. Right now I have a mortgage on my house in the amount of $1,130,000. The rate is 3.75%, 30 year term. As you probably know, mortgage interest is only deductible on the first $1mm of principal. Should I be paying down my mortgage to $1mm before investing more in our taxable account? 401Ks are already being maxed.

We are 31, and we think this may be our last home.

jpelder
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Re: Pay down mortgage, or invest?

Post by jpelder » Tue Dec 22, 2015 10:36 am

I guess it depends on your income. If you're saving more than 15% of your income towards retirement, and you plan on retiring at age 60-65, then you probably ought to just keep paying based on the regular amortization schedule. That's a pretty good interest rate, and rates are bound to go up in the future

ncole1
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Re: Pay down mortgage, or invest?

Post by ncole1 » Tue Dec 22, 2015 11:49 am

mpowered wrote:About a year ago, my wife and I moved into a substantially larger home. Right now I have a mortgage on my house in the amount of $1,130,000. The rate is 3.75%, 30 year term. As you probably know, mortgage interest is only deductible on the first $1mm of principal. Should I be paying down my mortgage to $1mm before investing more in our taxable account? 401Ks are already being maxed.

We are 31, and we think this may be our last home.
Mortgage prepayment is equivalent to illiquid, negative-convexity bonds. Decide on the dollar amount you want to go to equities/stocks, and then for the rest, compare the rate you'd get on your bonds to what you'd get by prepaying mortgage principal.

mmcmonster
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Re: Pay down mortgage, or invest?

Post by mmcmonster » Tue Dec 22, 2015 12:10 pm

All the investment gurus will say to invest the money and use the mortgage as a low interest rate loan and take as long as possible to pay it off.

I paid off my 15 year mortgage as fast as I could. Since then I sleep a lot better knowing that my house is paid off and I could survive indefinitely with a substantial pay cut.

Also, since the house is paid off, a larger percentage of my income goes into investments.

My suggestion (as someone who you don't know with little experience of my own): Maximize any 401k match and Roth. After that, every cent towards the mortgage.

RobLIC
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Re: Pay down mortgage, or invest?

Post by RobLIC » Tue Dec 22, 2015 12:16 pm

+1 mmcmonster

amphora
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Re: Pay down mortgage, or invest?

Post by amphora » Tue Dec 22, 2015 12:26 pm

ncole1 wrote:
mpowered wrote:About a year ago, my wife and I moved into a substantially larger home. Right now I have a mortgage on my house in the amount of $1,130,000. The rate is 3.75%, 30 year term. As you probably know, mortgage interest is only deductible on the first $1mm of principal. Should I be paying down my mortgage to $1mm before investing more in our taxable account? 401Ks are already being maxed.

We are 31, and we think this may be our last home.
Mortgage prepayment is equivalent to illiquid, negative-convexity bonds. Decide on the dollar amount you want to go to equities/stocks, and then for the rest, compare the rate you'd get on your bonds to what you'd get by prepaying mortgage principal.
I think this is a good way of looking at this. Certainly max out your tax advantaged accounts first, but if you're choosing between low yielding bonds and mortgage payments, I would go with the mortgage. I would also calculate the value of the mortgage interest deduction to you, which is based on your tax bracket and state of residence:
http://www.bankrate.com/calculators/mor ... lator.aspx

LateStarter1975
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Re: Pay down mortgage, or invest?

Post by LateStarter1975 » Tue Dec 22, 2015 1:08 pm

mmcmonster wrote:All the investment gurus will say to invest the money and use the mortgage as a low interest rate loan and take as long as possible to pay it off.

I paid off my 15 year mortgage as fast as I could. Since then I sleep a lot better knowing that my house is paid off and I could survive indefinitely with a substantial pay cut.

Also, since the house is paid off, a larger percentage of my income goes into investments.

My suggestion (as someone who you don't know with little experience of my own): Maximize any 401k match and Roth. After that, every cent towards the mortgage.
+1
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mpowered
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Re: Pay down mortgage, or invest?

Post by mpowered » Tue Dec 22, 2015 2:07 pm

That's an interesting way to think of it, that paying down my mortgage is essentially a risk free investment, with the return at my interest rate, 3.75%.

This goes down when it reduces my mortgage interest tax deduction, but until my principal on the loan is 1MM, I'll allocate what I would have been buying in Vanguard Total Bond Fund in my taxable account to paying down the mortgage.

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Re: Pay down mortgage, or invest?

Post by Bir48die » Tue Dec 22, 2015 2:09 pm

My goal has always been to pay off my mortgage. Have done it twice and I sleep much better as a result.

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Re: Pay down mortgage, or invest?

Post by Twins Fan » Tue Dec 22, 2015 2:16 pm

What tax bracket are you guys in? I assume a higher bracket due to the value of your home, but...

Your effective mortgage rate is likely lower than the 3.75% on the amount up to $1 million. But yes, you pay the full 3.75% rate on all over the $1 million. It does make sense to pay down the $130k to get to the $1million point, IMO. Then reevaluate.

I'm not a fan of the mortgage interest deduction for most folks (average joe). But, it's a nice deduction for those with a $1 million mortgage, all that interest paid, and if the effective rate is under 3%... I can see the point then.

Also, if you're in a higher tax bracket, you may not want to hold total bond in your taxable account. A muni fund may be a better choice.

azanon
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Re: Pay down mortgage, or invest?

Post by azanon » Tue Dec 22, 2015 2:20 pm

mpowered wrote:About a year ago, my wife and I moved into a substantially larger home. Right now I have a mortgage on my house in the amount of $1,130,000. The rate is 3.75%, 30 year term. As you probably know, mortgage interest is only deductible on the first $1mm of principal. Should I be paying down my mortgage to $1mm before investing more in our taxable account? 401Ks are already being maxed.

We are 31, and we think this may be our last home.
What I would want to know is if you have at least 3-6 months worth of an emergency fund. If not, I'd definitely build that up first, as its a lot less hassle to have cash on-hand in case of an emergency, than it is to do something complex to come up with cash in this scenario, such as withdrawing from an IRA and trying to avoid penalties, or home-equity loans.

But, once you have a nice cash cushion, preferably a sizable one, then yeah sure, pay the mortgage off next.

Though I think this is common sense, it is very similar to advice you'd get from a Dave Ramsey or Suze Orman.
Last edited by azanon on Tue Dec 22, 2015 2:33 pm, edited 2 times in total.

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Re: Pay down mortgage, or invest?

Post by cfs » Tue Dec 22, 2015 2:21 pm

Related

Here is this from Larry on the should I pay down the mortgage subject (related to this subject) viewtopic.php?f=10&t=180076&newpost=2728458#p2727824
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cherijoh
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Re: Pay down mortgage, or invest?

Post by cherijoh » Tue Dec 22, 2015 2:32 pm

mpowered wrote:That's an interesting way to think of it, that paying down my mortgage is essentially a risk free investment, with the return at my interest rate, 3.75%.

This goes down when it reduces my mortgage interest tax deduction, but until my principal on the loan is 1MM, I'll allocate what I would have been buying in Vanguard Total Bond Fund in my taxable account to paying down the mortgage.
The only problem with this approach is that if equities tank and you want to rebalance your portfolio, you can't sell a corner of the house to buy equities.

Also, if heaven forbid you or your spouse loses your job, it's good to have non-retirement assets that aren't 100% invested in the stock market. Recessions and stock market pull backs go hand in hand. HELOCs can be a source of cash, but keep in mind that the lender can yank your LOC if your circumstances change OR the value of your home decreases. If you owe more than your house is worth but are keeping up with the payments the bank can't call your loan.

Personally, I would be leery about tying too much of my net worth up in home equity. That is an expensive house, so I assume that you live in a HCOL area. You probably depleted your non-retirement assets a lot to make the down payment, so I would want to make sure my liquid assets were in good shape before trying to aggressively pay down your mortgage.

passiveincome
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Re: Pay down mortgage, or invest?

Post by passiveincome » Tue Dec 22, 2015 3:20 pm

Pay it off as aggressively as you can. Even at a low interest rate the interest you pay is crazy. I am almost done with my mortgage. Monthly interest is under 500 bucks a month now.

On a million dollar loan your interest will be 3300 a month and you get nothing for it. Don't get seduced by the stupid mortgage rate interest deduction. It is more or less worthless. Seriously do the math on what a 40k deduction does for you. Not much especially when considering you lose your standard deduction which is 13k I think.

Even at a high tax bracket which I am also in. So I speak from personal experience and not speculating what it would be like to have a high income and large house. My .02

daveatca
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Down we go

Post by daveatca » Tue Dec 22, 2015 4:41 pm

mmcmonster wrote:I sleep a lot better knowing that my house is paid off
Winner!
We did that in 2011.
Should we have done mortgage + investments? Yes.
But, sleeping is good.

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Re: Pay down mortgage, or invest?

Post by Twins Fan » Tue Dec 22, 2015 4:50 pm

passiveincome wrote:On a million dollar loan your interest will be 3300 a month and you get nothing for it. Don't get seduced by the stupid mortgage rate interest deduction. It is more or less worthless. Seriously do the math on what a 40k deduction does for you. Not much especially when considering you lose your standard deduction which is 13k I think.
That's why I think the mortgage interest deduction basically only makes sense for high income and high mortgage folks. I'm not exactly sure what the standard deduction is either for a married couple, but I believe it's close to the 13k you mention. I would assume the property taxes alone on a million dollar plus home are well over the 13k, and then whatever else they may use in that area like charitable contributions and so on. All of their interest paid gets the deduction benefit then. Let's say the 35% bracket... the pay $40k in interest, but get 35% of it back by the deduction ($14k). That's not a bad deal. The OP is looking at a 2.4375% effective rate using the 35% bracket again... also not a bad deal.

The standard deduction is not lost. That's given to everyone. If one can itemize and exceed or far exceed the standard deduction, as the OP and probably you do, they win not lose.

Now, I am also one to usually say pay off a mortgage ASAP. But, I also don't have a million dollar home and don't hang out in the 30 something percent tax brackets.

I don't think the OP was asking if they should pay the whole mortgage down aggressively. I don't think they plan to do that anyway. They seem to only be asking if they should pay it down aggressively to get it to the $1 million point. I don't know...

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Re: Pay down mortgage, or invest?

Post by emoore » Tue Dec 22, 2015 4:58 pm

So I've always wondered if people actually do sleep better when they pay off their mortgage. I'm not sure that I would. Sure paying off CC debt or a car loan would make me sleep better but not sure about the mortgage. I think I would be more stressed having so much of my net worth tied up in an illiquid asset. But that's just me. I have a the same interest rate as the OP, 3.75% but I don't think I'm going to aggressively pay off the mortgage. I'll put some extra toward it but not every cent and certainty not money that could be used to max out my 401k and roth IRA.

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Re: Pay down mortgage, or invest?

Post by Twins Fan » Tue Dec 22, 2015 5:14 pm

I don't know of anyone that recommends throwing every penny at the mortgage just to get rid of it and not saving or investing a dime along the way. And, the OP said their 401ks are being maxed already. I assumed the OP has some discretionary income when talking about $1 million plus homes.

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Re: Pay down mortgage, or invest?

Post by Grt2bOutdoors » Tue Dec 22, 2015 6:06 pm

mpowered wrote:About a year ago, my wife and I moved into a substantially larger home. Right now I have a mortgage on my house in the amount of $1,130,000. The rate is 3.75%, 30 year term. As you probably know, mortgage interest is only deductible on the first $1mm of principal. Should I be paying down my mortgage to $1mm before investing more in our taxable account? 401Ks are already being maxed.

We are 31, and we think this may be our last home.
Pay down the mortgage to $1,000,000; but only if you have stable employment and at least 1 years of expenses in an FDIC insured savings account. Do you have it?
After that, take 1/3 of your monthly disposable income and pre-pay your forever home mortgage. Take the other 2/3's and create a 3 Fund Portfolio - Total Stock, Total International Stock and Tax Exempt Intermediate. Consider this to be part of your retirement portfolio. Your mortgage is costing you $65K a year in principal and interest alone and you will be paying it for the next 30 years. If that doesn't motivate you to pay off your mortgage faster, I don't know what will. If you are living in a home that has a $1.1 million dollar mortgage, it goes without saying you are in a high tax bracket. Don't pay more in taxes than you have to. Invest in tax-efficient index funds and municipal bonds.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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mpowered
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Re: Pay down mortgage, or invest?

Post by mpowered » Tue Dec 22, 2015 7:13 pm

Thanks for all the input here. Yes, we have a 12 mo emergency fund built up. Yes, we are in a high tax bracket.

Major considerations here are as follows:

(1) 3.75% is very low cost of capital, especially when taking into account the mortgage interest tax deduction, this drops the rate closer to something like 3%. By maintaining the mortgage, this frees up additional capital to be invested which will likely gain much more than 3.75% annual return.

(2) Running my amortization tables, if I were to throw an extra $5K a month towards the mortgage every month, I can get the mortgage completely paid off in something like 11 years. We can probably do this while saving an additional $5K a month towards the three fund portfolio mentioned in the earlier posts. It seems like a good compromise vs throwing an extra $10K per month at the mortgage, while only accelerating our timeline to being mortgage free by 4 years (7 year payoff in the $10K extra payment per month scenario).

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Re: Pay down mortgage, or invest?

Post by BolderBoy » Wed Dec 23, 2015 12:55 am

mpowered wrote:(1) 3.75% is very low cost of capital, especially when taking into account the mortgage interest tax deduction, this drops the rate closer to something like 3%. By maintaining the mortgage, this frees up additional capital to be invested which will likely gain much more than 3.75% annual return.
One counter to this argument goes like this: "If your home were paid off, would you be willing to take out a new mortgage (at an appropriately low interest rate) in order to invest in the stock market?"
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

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Re: Pay down mortgage, or invest?

Post by itstoomuch » Wed Dec 23, 2015 1:14 am

If with Kids; We did UGMA (529 not invented then). In 2016, no grand kids but high retirement income, we will do 529 to get extra years of savings and of course the tax credits. :oops: In fact doing prelim 2015 tax and will need to see the impact of 2015 contributions. 8-)

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RandomPointer
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Re: Pay down mortgage, or invest?

Post by RandomPointer » Wed Dec 23, 2015 1:58 am

As mentioned, mortgage prepayment is illiquid.

I have only about 10 months worth of emergency fund, and still building. After I have a year worth of emergency fund, maxed out my retirement accounts, put money into college fund, and my overall portfolio value is twice of my house value, then I will start prepayment.

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Re: Pay down mortgage, or invest?

Post by sambb » Wed Dec 23, 2015 4:48 am

why does it have to be one or the other? invest half, use half to pay down mortgage. You get a little of each of two competing philosophies.

SGM
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Re: Pay down mortgage, or invest?

Post by SGM » Wed Dec 23, 2015 5:33 am

I chose to fully pay off my mortgage early. I was 100% invested in the stock market and did not consider that paying off the mortgage was a negative bond. With all the different obligations that go with home ownership I don't think too much of it as an investment.

I needed a roof over my head and I did not want to lose it. If I had a lot sunk in it and for some reason couldn't continue payments I would lose additional principal too, so it seemed better to pay it off completely rather than partially. When I stopped paying a monthly mortgage I invested the difference in the stock market. Interest rates were a lot higher then they are now. I never stopped maximizing retirement plans.

In rising real estate markets a mortgage gives you leverage. I owned a house in a market that became hot and it doubled in value in a few years. Unfortunately it is difficult to predict these markets. The couple we had bought from had sold the house to save more money to buy a better house. They were priced out of the market.

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Re: Pay down mortgage, or invest?

Post by joebh » Wed Dec 23, 2015 8:06 am

SGM wrote:I needed a roof over my head and I did not want to lose it.
Under what conditions would you have lost it?
In rising real estate markets a mortgage gives you leverage.
I'm not sure what you mean here. What leverage does a mortgage give you that depends on a rising market?

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Re: Pay down mortgage, or invest?

Post by Toons » Wed Dec 23, 2015 8:09 am

mmcmonster wrote:All the investment gurus will say to invest the money and use the mortgage as a low interest rate loan and take as long as possible to pay it off.

I paid off my 15 year mortgage as fast as I could. Since then I sleep a lot better knowing that my house is paid off and I could survive indefinitely with a substantial pay cut.

Also, since the house is paid off, a larger percentage of my income goes into investments.

My suggestion (as someone who you don't know with little experience of my own): Maximize any 401k match and Roth. After that, every cent towards the mortgage.

+1-Perfect :happy
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Re: Pay down mortgage, or invest?

Post by azanon » Wed Dec 23, 2015 8:25 am

mpowered wrote:Thanks for all the input here. Yes, we have a 12 mo emergency fund built up. Yes, we are in a high tax bracket.

Major considerations here are as follows:

(1) 3.75% is very low cost of capital, especially when taking into account the mortgage interest tax deduction, this drops the rate closer to something like 3%. By maintaining the mortgage, this frees up additional capital to be invested which will likely gain much more than 3.75% annual return.
So just come full circle in terms of honesty about what you're wanting to do, if you want to do this. Full circle is that you want to use leverage to invest. There's no difference between doing this, and setting up a brokerage account and then investing on margin with the borrowed rate being whatever your mortgage is.

If you're ok with levered investing, then have at it. Me? Once I have my IRAs fully funded, and an emergency fund, next in line is paying off the mortgage. Levered investing in a taxable is not my style, and dare I say it isnt the style of a typical boglehead.

Also, I'm not sure I can agree that's a low cost of capital. VBRIX (Vanguard's short-term bond index) only yields 1.38% currently, and that rate is more than twice that.

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Re: Pay down mortgage, or invest?

Post by Leemiller » Wed Dec 23, 2015 8:40 am

We live in a HCOL state and have a mortgage of about 900k @ 3.5%. After federal and state tax considerations, our effective rate is something like 2%. We don't "lose" the standard deduction because between property taxes, state income taxes and charitable donations we would never take the standard deduction.

My goal is to eventually have enough in taxable accounts to "earn" enough for our monthly mortgage payment. I also don't want too much of our net worth tied up in our home, which at its market value could be illiquid for some time.

In addition to the 401ks, we do a back door Roth, max HDHP and 529 contributions each year.

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Re: Pay down mortgage, or invest?

Post by SGM » Wed Dec 23, 2015 10:36 am

joebh wrote:
SGM wrote:I needed a roof over my head and I did not want to lose it.
Under what conditions would you have lost it?
In rising real estate markets a mortgage gives you leverage.
I'm not sure what you mean here. What leverage does a mortgage give you that depends on a rising market?
I hear about people losing their equity in their house when they can no longer make their payments and go into foreclosure. I had an acquaintance who counted on people not being able to make their payments so that he could take over the property. Not that I realistically thought I would ever lose my home, but if there were a series of catastrophic events it might have been possible. Although maybe I would have kept my home, but catastrophic events might have made living in the style I had become accustomed to more difficult.

Those who bought homes in the NY metropolitan area generally took out mortgages and the homes are worth 50 times what they paid for them after WWII. Their payments were easier to bear as wages went up. That seems to be a benefit of leverage in a rising market. At the same time some who bought homes in the rust belt saw the values go nowhere over the same period of time. I have an uncle who sold his house 5 years ago for less than what he paid for it in 1946. My interpretation of those different outcomes is that one benefitted from leverage and the other did not.

I wasn't addressing the leverage one gets by investing in the stock market with funds that would have been used to pay off a mortgage early. I was looking at simply the leverage of a mortgage with rising home prices.

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Re: Pay down mortgage, or invest?

Post by Twins Fan » Wed Dec 23, 2015 10:50 am

SGM, you're using "leverage" to describe too many things.

A mortgage can be viewed as an inflation hedge, which is what you described where the mortgage payment got more affordable as inflation, wages, and home values went up.

Home appreciation is simply appreciation.

Leverage is what it is... you have a loan taken out and rather than send extra dollars to the borrowed money you send them to investments.

A mortgage as leverage in a rising home environment.... is a made up thing. :happy

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Re: Pay down mortgage, or invest?

Post by cusetownusa » Wed Dec 23, 2015 11:03 am

emoore wrote:So I've always wondered if people actually do sleep better when they pay off their mortgage. I'm not sure that I would. Sure paying off CC debt or a car loan would make me sleep better but not sure about the mortgage. I think I would be more stressed having so much of my net worth tied up in an illiquid asset. But that's just me. I have a the same interest rate as the OP, 3.75% but I don't think I'm going to aggressively pay off the mortgage. I'll put some extra toward it but not every cent and certainty not money that could be used to max out my 401k and roth IRA.
Im with you...I am very debt averse and would like to be debt free. However, I don't get the line of thinking when people say that they sleep better at night or that they would be better off if they lost their job if the house is paid off.

For example, I have about $250,000 left on my mortgage (3.75%) and will soon (over the next few years) have $250,000 in taxable accounts saved up. At this point I will decide whether to pay off the house all at once or not. Would I really sleep better with no mortgage and $0 in taxable savings versus a $250,000 mortgage and $250,000 in liquid taxable savings? Also, seems to me if I did lose my job I would be better off with the mortgage and the savings versus no mortgage and no savings.

I am not advocating either decision as I don't think you could go wrong either way...I am just challenging that line of though regarding paying off the mortgage.

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Re: Pay down mortgage, or invest?

Post by joebh » Wed Dec 23, 2015 11:10 am

SGM wrote:I hear about people losing their equity in their house when they can no longer make their payments and go into foreclosure. I had an acquaintance who counted on people not being able to make their payments so that he could take over the property. Not that I realistically thought I would ever lose my home, but if there were a series of catastrophic events it might have been possible. Although maybe I would have kept my home, but catastrophic events might have made living in the style I had become accustomed to more difficult.
So you were worried that you couldn't make payments and would go into foreclosure. Yet, you had the money to pay off your mortgage.
If you had the money, why would you no longer make be able to payments? Were you afraid you would somehow lose your payoff money due to some catastrophic events? If these catastrophic events occurred after you had paid off your mortgage, you wouldn't have sold your home?

I guess I can understand an emotional reaction (the "we're debt free!" Dave Ramsey scream), but this fear of losing the roof over your head that I hear from folks who pay off their mortgages seems rather unfounded to me in today's world.

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Re: Pay down mortgage, or invest?

Post by arsenalfan » Wed Dec 23, 2015 11:18 am

I support paying down to $1 mil, then do whatever mix of pay-down vs invest makes sense to you. Your 50/50 sounds a reasonable compromise to me.

If you're in the 39.6% bracket, 3.75% = 2.336% after mortgage interest deduction (using the bankrate calculator linked above). Will investments beat 2.336% guaranteed going forward? Seems impossible/possible/probable depending on who you read. Me, I think it possible my after-tax investments may beat that.

Separately, I think it logical to not have most of your net worth in an illiquid home. HELOCs exist, but may disappear in times of need/recession. I prefer cash.

So split the difference and throw surplus at BOTH the mortgage AND your after tax account.
Last edited by arsenalfan on Wed Dec 23, 2015 11:25 am, edited 2 times in total.

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Re: Pay down mortgage, or invest?

Post by sesq » Wed Dec 23, 2015 11:19 am

You can deduct up to 100K of a HEL or HELOC in addition to the $1M cap on mortgages. So you may be able to borrow as a HELOC, pay down the mortgage and shift an additional $100K into the "deductible" category. It would depend on how the HELOC rates compare to the 3.75% mortgage and whether a bank would write it based on your LTV ratio. Around me I see a lot of HELOC's with a 2% teaser rate, then a shift to prime +/- 25-50 basis points. Obviously there is a risk with shifting to a variable rate product that should also be considered along with the cashflow consequences of having to service two debts. In addition, if you didn't pay to have the first not "recast" you would still be making payments based on the original 1.13M amortization schedule along with the HELOC payment.

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mpowered
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Re: Pay down mortgage, or invest?

Post by mpowered » Wed Dec 23, 2015 11:51 am

BolderBoy wrote:
mpowered wrote:(1) 3.75% is very low cost of capital, especially when taking into account the mortgage interest tax deduction, this drops the rate closer to something like 3%. By maintaining the mortgage, this frees up additional capital to be invested which will likely gain much more than 3.75% annual return.
One counter to this argument goes like this: "If your home were paid off, would you be willing to take out a new mortgage (at an appropriately low interest rate) in order to invest in the stock market?"

Great point. I'm not sure that I would...

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Re: Pay down mortgage, or invest?

Post by joebh » Wed Dec 23, 2015 12:05 pm

mpowered wrote:
BolderBoy wrote:
mpowered wrote:(1) 3.75% is very low cost of capital, especially when taking into account the mortgage interest tax deduction, this drops the rate closer to something like 3%. By maintaining the mortgage, this frees up additional capital to be invested which will likely gain much more than 3.75% annual return.
One counter to this argument goes like this: "If your home were paid off, would you be willing to take out a new mortgage (at an appropriately low interest rate) in order to invest in the stock market?"

Great point. I'm not sure that I would...
If I offered you a way that you could borrow money at 1% and get an investment return of 2%, would you do it?

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Yesterdaysnews
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Re: Pay down mortgage, or invest?

Post by Yesterdaysnews » Wed Dec 23, 2015 12:17 pm

I paid off my house in 2 yrs on a 15 yr note. The main benefit for me is the improved monthly cash flow. I can now withstand a significant drop in monthly income (hope it never happens obviously) without any significant change in lifestyle for myself and the family.

While I have a stable job you just never know when different market dynamics will turn on you and income will drop. Having a healthy positive monthly cash flow is a good safety net in my opinion.

cusetownusa
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Re: Pay down mortgage, or invest?

Post by cusetownusa » Wed Dec 23, 2015 12:47 pm

Yesterdaysnews wrote:I paid off my house in 2 yrs on a 15 yr note. The main benefit for me is the improved monthly cash flow. I can now withstand a significant drop in monthly income (hope it never happens obviously) without any significant change in lifestyle for myself and the family.

While I have a stable job you just never know when different market dynamics will turn on you and income will drop. Having a healthy positive monthly cash flow is a good safety net in my opinion.
Again, why would it be any different if you had a pile of liquid savings/investments instead of the paid off mortgage? I can see why people like to pay off their mortgage debt but I don't get this part of the reasoning. Why wouldn't your lifestyle change with a paid off house but it would by having a mortgage and the equivalent in savings instead?

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BolderBoy
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Re: Pay down mortgage, or invest?

Post by BolderBoy » Wed Dec 23, 2015 1:02 pm

joebh wrote:
mpowered wrote:
BolderBoy wrote:
mpowered wrote:(1) 3.75% is very low cost of capital, especially when taking into account the mortgage interest tax deduction, this drops the rate closer to something like 3%. By maintaining the mortgage, this frees up additional capital to be invested which will likely gain much more than 3.75% annual return.
One counter to this argument goes like this: "If your home were paid off, would you be willing to take out a new mortgage (at an appropriately low interest rate) in order to invest in the stock market?"

Great point. I'm not sure that I would...
If I offered you a way that you could borrow money at 1% and get an investment return of 2%, would you do it?
If you GUARANTEED the return, then probably. Are you?
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

poker27
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Re: Pay down mortgage, or invest?

Post by poker27 » Wed Dec 23, 2015 1:31 pm

cusetownusa wrote:
Yesterdaysnews wrote:I paid off my house in 2 yrs on a 15 yr note. The main benefit for me is the improved monthly cash flow. I can now withstand a significant drop in monthly income (hope it never happens obviously) without any significant change in lifestyle for myself and the family.

While I have a stable job you just never know when different market dynamics will turn on you and income will drop. Having a healthy positive monthly cash flow is a good safety net in my opinion.
Again, why would it be any different if you had a pile of liquid savings/investments instead of the paid off mortgage? I can see why people like to pay off their mortgage debt but I don't get this part of the reasoning. Why wouldn't your lifestyle change with a paid off house but it would by having a mortgage and the equivalent in savings instead?
This. IMO there is a strong bias for people to payoff their mortgage on this forum.

If I paid off my house, did not invest in a taxable, and lost my job... Thankfully I would not have a mortgage payment to make. However, I will have other expenses, RE taxes, assessments, and typical homeowner expenses. If I have to replace a roof, and other things my EF may run dry and I get foreclosed on.

If I did not pay off my house, invested in taxable, and lost my job... I will have 200k ish laying around to meet my monthly mortgage payment, pay taxes, expenses, ect. It would take me a looong time to run through this + my emergency fund.

We dont know what the correct answer is. If someone began paying off their mortgage in 2009 they would be way behind someone that invested in equities. Personally, I have mainly been investing in taxable, with a few bucks annually going towards mortgage principal. Since I recently reached a taxable 'goal', I will most likely split my contributions to both.

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powermega
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Re: Pay down mortgage, or invest?

Post by powermega » Wed Dec 23, 2015 2:19 pm

If you believe you can find a lower risk investment(s) that has an after-tax return that exceeds the tax-equivalent mortgage rate, then you're better off investing the money and not paying down the mortgage. To me, the decision really is that mechanical. I understand the psychological justification of paying off your mortgage and owning your home "free and clear". To me, it is just that: a psychological justification. Prepaying a mortgage does lock up wealth in a relatively Illiquid investment while investing the money keeps more of your wealth in liquid investments that can be used for a variety of purposes. We have a 3.25% mortgage on our home and I doubt we will ever pay an extra penny towards it. To us, it just doesn't make sense given the need for investments in 529 plans and taxable accounts, even after maxing out our qualified accounts.

Keep in mind that this is a decision that you should revisit periodically. Investment conditions change. If the investments that you can get are not producing an after-tax return that exceeds your tax-equivalent mortgage rate, then you can then start prepaying the mortgage, and even liquidating some of those investments to make some lump-sum payments on the mortgage. Send the next dollar to its best use, and get in the habit of asking the question about what that best use is.
Even a stopped clock is right twice a day.

Tri-Tip
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Re: Pay down mortgage, or invest?

Post by Tri-Tip » Wed Dec 23, 2015 2:47 pm

Of the money that I have available to invest, I put 20-25% against my mortgage, about 10% into Money Market funds (so I can sleep at night), and the rest in Mutual Funds.

SGM
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Re: Pay down mortgage, or invest?

Post by SGM » Wed Dec 23, 2015 3:36 pm

Twins Fan wrote:SGM, you're using "leverage" to describe too many things.

A mortgage can be viewed as an inflation hedge, which is what you described where the mortgage payment got more affordable as inflation, wages, and home values went up.

Home appreciation is simply appreciation.

Leverage is what it is... you have a loan taken out and rather than send extra dollars to the borrowed money you send them to investments.

A mortgage as leverage in a rising home environment.... is a made up thing. :happy
Hi Twins Fan I appreciate your comment.


Some people and real estate investors consider a mortgage to be leverage. I had it presented to me that way as a child. There is another context in using the other money that might go into paying down the mortgage to leverage stock and bond investments.
See:
http://www.investopedia.com/articles/mo ... -worth.asp

SGM
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Re: Pay down mortgage, or invest?

Post by SGM » Wed Dec 23, 2015 3:46 pm

joebh wrote:
SGM wrote:I hear about people losing their equity in their house when they can no longer make their payments and go into foreclosure. I had an acquaintance who counted on people not being able to make their payments so that he could take over the property. Not that I realistically thought I would ever lose my home, but if there were a series of catastrophic events it might have been possible. Although maybe I would have kept my home, but catastrophic events might have made living in the style I had become accustomed to more difficult.
So you were worried that you couldn't make payments and would go into foreclosure. Yet, you had the money to pay off your mortgage.
If you had the money, why would you no longer make be able to payments? Were you afraid you would somehow lose your payoff money due to some catastrophic events? If these catastrophic events occurred after you had paid off your mortgage, you wouldn't have sold your home?


I guess I can understand an emotional reaction (the "we're debt free!" Dave Ramsey scream), but this fear of losing the roof over your head that I hear from folks who pay off their mortgages seems rather unfounded to me in today's world.
Joebh,
Thanks for your comments. I would not say I was worried about losing my home. I absolutely did not have any fear. :D I always consider all possibilities in planning. With my mortgage paid off, I had the freedom to take more risk in investments. Would you recommend a retiree to take on a mortgage? I don't recall a strong emotional response a la Dave Ramsey. I don't listen or read this guy.
"Let us endeavor, so to live, that when we die, even the undertaker will be sorry." Mark Twain

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Yesterdaysnews
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Re: Pay down mortgage, or invest?

Post by Yesterdaysnews » Wed Dec 23, 2015 3:48 pm

cusetownusa wrote:
Yesterdaysnews wrote:I paid off my house in 2 yrs on a 15 yr note. The main benefit for me is the improved monthly cash flow. I can now withstand a significant drop in monthly income (hope it never happens obviously) without any significant change in lifestyle for myself and the family.

While I have a stable job you just never know when different market dynamics will turn on you and income will drop. Having a healthy positive monthly cash flow is a good safety net in my opinion.
Again, why would it be any different if you had a pile of liquid savings/investments instead of the paid off mortgage? I can see why people like to pay off their mortgage debt but I don't get this part of the reasoning. Why wouldn't your lifestyle change with a paid off house but it would by having a mortgage and the equivalent in savings instead?
Presumable you would invest that money in stocks correct? What if we are in the midst of 2008 and you lose half your income due to recession? You then have to sell to meet your cash flow needs which is the worst time.

SGM
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Re: Pay down mortgage, or invest?

Post by SGM » Wed Dec 23, 2015 4:07 pm

joebh wrote:
SGM wrote:I hear about people losing their equity in their house when they can no longer make their payments and go into foreclosure. I had an acquaintance who counted on people not being able to make their payments so that he could take over the property. Not that I realistically thought I would ever lose my home, but if there were a series of catastrophic events it might have been possible. Although maybe I would have kept my home, but catastrophic events might have made living in the style I had become accustomed to more difficult.
So you were worried that you couldn't make payments and would go into foreclosure. Yet, you had the money to pay off your mortgage.
If you had the money, why would you no longer make be able to payments? Were you afraid you would somehow lose your payoff money due to some catastrophic events? If these catastrophic events occurred after you had paid off your mortgage, you wouldn't have sold your home?


I guess I can understand an emotional reaction (the "we're debt free!" Dave Ramsey scream), but this fear of losing the roof over your head that I hear from folks who pay off their mortgages seems rather unfounded to me in today's world.
I would not say I was worried about losing my home. I absolutely did not have any fear. I do not consider a home to be a very liquid investment unless there is a hot market. I had an mortgage when 8% was the going rate and there is an AMT that some of us have to pay. Having a mortgage had little benefit for me.

I don't recall a strong emotional response or scream a la Dave Ramsey when I paid off my mortgage. Besides when I paid off my mortgage I still had real estate taxes to pay.

Sorry that the phrase "keeping a roof over my head" is so objectionable. I will be careful not to use such emotionally charged words in my future posts.

joebh
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Re: Pay down mortgage, or invest?

Post by joebh » Wed Dec 23, 2015 5:09 pm

SGM wrote: I would not say I was worried about losing my home. I absolutely did not have any fear. I do not consider a home to be a very liquid investment unless there is a hot market. I had an mortgage when 8% was the going rate and there is an AMT that some of us have to pay. Having a mortgage had little benefit for me.

I don't recall a strong emotional response or scream a la Dave Ramsey when I paid off my mortgage. Besides when I paid off my mortgage I still had real estate taxes to pay.

Sorry that the phrase "keeping a roof over my head" is so objectionable. I will be careful not to use such emotionally charged words in my future posts.
Thanks for the answer.

It's not objectionable, I just don't understand it as a worry when the money that would otherwise pay off the mortgage exists. I understand people worrying when they buy so much house that they are house-poor, but those folks don't have the option to pay off their mortgages.

I view the "carry a mortgage" discussion and the "delay collecting social security" discussion as the same. I don't expect to convince anyone - I just keep trying to understand the thinking. I'm getting there...

Twins Fan
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Re: Pay down mortgage, or invest?

Post by Twins Fan » Wed Dec 23, 2015 6:34 pm

SGM wrote:
Twins Fan wrote:SGM, you're using "leverage" to describe too many things.

A mortgage can be viewed as an inflation hedge, which is what you described where the mortgage payment got more affordable as inflation, wages, and home values went up.

Home appreciation is simply appreciation.

Leverage is what it is... you have a loan taken out and rather than send extra dollars to the borrowed money you send them to investments.

A mortgage as leverage in a rising home environment.... is a made up thing. :happy
Hi Twins Fan I appreciate your comment.


Some people and real estate investors consider a mortgage to be leverage. I had it presented to me that way as a child. There is another context in using the other money that might go into paying down the mortgage to leverage stock and bond investments.
See:
http://www.investopedia.com/articles/mo ... -worth.asp
Yes, thank you... that's exactly what I meant in my "Leverage is what it is" part. :wink:

cusetownusa
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Re: Pay down mortgage, or invest?

Post by cusetownusa » Wed Dec 23, 2015 6:38 pm

Yesterdaysnews wrote:
cusetownusa wrote:
Yesterdaysnews wrote:I paid off my house in 2 yrs on a 15 yr note. The main benefit for me is the improved monthly cash flow. I can now withstand a significant drop in monthly income (hope it never happens obviously) without any significant change in lifestyle for myself and the family.

While I have a stable job you just never know when different market dynamics will turn on you and income will drop. Having a healthy positive monthly cash flow is a good safety net in my opinion.
Again, why would it be any different if you had a pile of liquid savings/investments instead of the paid off mortgage? I can see why people like to pay off their mortgage debt but I don't get this part of the reasoning. Why wouldn't your lifestyle change with a paid off house but it would by having a mortgage and the equivalent in savings instead?
Presumable you would invest that money in stocks correct? What if we are in the midst of 2008 and you lose half your income due to recession? You then have to sell to meet your cash flow needs which is the worst time.
I get that point but Why would the money have to be invested in stocks? Seems a bit risky based on your example.

Also, I am not against paying off a mortgage, I just don't understand that part of the reasoning. In fact, In the event that I lost a significant portion of my income I would feel better having $200,000 in savings and a mortgage versus no mortgage and zero savings, but that is just me I guess.

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