When does it make sense to start paying down (or off) a low rate mortgage?

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panhead
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When does it make sense to start paying down (or off) a low rate mortgage?

Post by panhead » Thu Apr 20, 2017 12:27 pm

The question of whether or not to pay down a mortgage is a staple on this and many other sites, as we are all very aware, so I hope this question is different enough that it doesn't go down the same rabbit hole.

So, the question is, if you have a low rate mortgage (say 3% in todays environment) Is there a threshold when it makes more sense to prioritize paying off the mortgage rather than continue to invest? I ask this primarily from the viewpoint of someone who is still in accumulation mode who is considering early retirement. Let's assume a mid 40s to mid 50s person.
Possible answers:

1) (X) times expenses in investments
2) The above with (Y) times investments easily accessible (ie, in taxable)
3) When bond rates are lower than the after-tax cost of your mortgage
4) When Jupiter is in retrograde
5) ???

The usual question usually gets a response of "I'd invest" or "I'd pay off the mortgage" this question is trying to figure out if there is a factor or series of factors that would make paying down the mortgage more of a priority than investing. The answer could be anything, qualitative or quantitative, just looking for perspective.
Note, at retirement, I believe most of us would want a paid off mortgage, that is why I took this as someone who is still in accumulation mode.

Anyway, what do you think?

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Pranav » Thu Apr 20, 2017 12:37 pm

I maximize my contributions to tax-advantaged accounts and then throw the leftover income towards the mortgage.
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by alex_686 » Thu Apr 20, 2017 12:40 pm

panhead wrote:3) When bond rates are lower than the after-tax cost of your mortgage


Number 3 is kind of close to the correct answer.

What you want to do is look at your entire portfolio and figure out what the best asset allocation is. Often it is better to add stocks because they will offer a better risk adjusted return than paying down your mortgage. #3 is the edge solution for the truly risk adverse. If one is extremely risk adverse one should pay down their mortgage as a investment until you hit the tipping point where bonds offer the better after tax returns.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by avalpert » Thu Apr 20, 2017 12:44 pm

When the cost of debt exceeds the expected return on capital - within whatever risk parameters you are comfortable with.

Personally, I don't care about not having a mortgage in retirement per se - if the debt is as cheap as it is now I am more then happy to let them lend it to me.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by jimb_fromATL » Thu Apr 20, 2017 12:45 pm

IF
    You have maxed contributions to all available tax-deferred and tax-advantaged retirement plans such as 401(k), 403(b), IRAs, TSP, SEP, etc.;

      ...and IF you have adequate liquid assets set aside for emergencies (at least six months to a year of living expenses);

      ...and IF you have paid off virtually all consumer debts (expect perhaps student loans);
    THEN
      ...you cannot likely beat the absolutely guaranteed equivalent rate of return for the investment of after-tax money with no risk to the principal that you get for paying off a mortgage faster ... even at today's low mortgage rates.

In fact the equivalent rate of return for paying down the mortgage is better than the mortgage rate itself because you would pay tax on the income in most after-tax investments, but there is no tax on extra money that you keep for yourself by NOT paying it out as mortgage interest according to the original schedule.

Just bear in mind that paying off the mortgage faster is somewhat like buying a series of CDs or bonds that are absolutely guaranteed, but which are not diversified and which you cannot easily cash out until their maturity date

... which is effectively when you sell the home and realize the improvement in your net worth in the form of reduced debt; or when it's paid off earlier. When it's paid off early, you could think of the gain as the equivalent of buying an annuity that guarantees a monthly income equivalent to the pre-tax mortgage payment for the remaining time in the original mortgage schedule.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by PVW » Thu Apr 20, 2017 12:58 pm

Another consideration is future inflation rate. A mortgage is an inflation hedge because you are paying off today's expenditures with tomorrow's inflated dollars. If you expect high inflation, then keep a low rate mortgage and vice versa.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by jlcnuke » Thu Apr 20, 2017 1:06 pm

5) When peace of mind from being debt free is valued by you more than the potential higher returns you may generate by investing the money instead.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by JDCarpenter » Thu Apr 20, 2017 1:11 pm

We fit most of your criteria, and I don't know if we will pay it off until when/if we sell the house (2.75% 15 year, right at 6 months into it)

we have 45 times (pretax) last year's expenses and 25-30 times high expenses of early retirement years. Saving more than we spend post-tax, and even more than our taxes. No other debts that aren't paid in full monthly. Retiring this summer in mid-50s. Both maxed our available pretax accounts until this year. (This year's tax rate is going to be the same as retirement tax rate, so not doing so now, although one of us is maxing Roth 401k.)

Mtg is 1/10 of our anticipated monthly spend. I wanted to pay it off rather than refinance, but could not convince spouse that it was the best use of the money given fixed 2.75.

PS--jlcnuke's fifth option is true for us, and I don't know that we'll hit that.
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Watty
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Watty » Thu Apr 20, 2017 1:51 pm

There is a wiki on this if you have not seen it.

https://www.bogleheads.org/wiki/Paying_ ... _investing

To your list of factors I would add;

6) As the percentage of bonds in your target asset allocation increases it makes less sense to keep the mortgage because a high percentage or the funds that could be used to pay off the mortgage would just be invest in bonds.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by SRenaeP » Thu Apr 20, 2017 2:17 pm

For me, the answer is -

after maxing out all tax-advantaged space,
no other debt,
only pay enough extra to hit a target date vs put all extra money to the mortgage.

I would set the target as 15 yrs after home purchase or 5 yrs before planned retirement date, whichever is sooner.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by LateStarter1975 » Thu Apr 20, 2017 2:46 pm

Pranav wrote:I maximize my contributions to tax-advantaged accounts and then throw the leftover income towards the mortgage.


+1
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by harvestbook » Thu Apr 20, 2017 3:15 pm

When my small business took off, after maxing my retirement and HSA, we aggressively paid off our mortgage over two years (2011-2012.) In hindsight, putting it all in the market would've been the better choice, but the payoff gave us immense freedom, boosted our savings rate, and broadened our options. We then bought a modest vacation home for cash that we don't have to worry about renting out. Our savings rate is now over 50 percent. I don't have to worry about a place to stay in a financial emergency. I can invest a little more aggressively than I might otherwise (not sure this is a positive!)

A lot of people make assumptions such as being able to sell their house whenever they want, as fast as they want, for their desired amount, and never consider they're going to have to buy another house or pay rent. I view houses as liabilities, not assets, so why not diminish the liability and risk? At best, it's a low-cost base from which to build wealth. At worst, it's a money pit over most of a lifetime. I understand the appeal of assuming an 8 percent market return is practically a given, because we all suffer recency bias. That's just not a bet I want to make.
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by bertilak » Thu Apr 20, 2017 3:26 pm

"When does it make sense to start paying down (or off) a low rate mortgage?"

When you want to improve your cash flow.
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by ved » Thu Apr 20, 2017 3:57 pm

I had my remaining mortgage amount at about half of my emergency fund around end of last year. At the rate I was paying my mortgage, it would have taken 3 years to pay it off (at about 3% rate).

I decided to pay off the mortgage with my emergency fund, and get a better return on that money than the 1% it was collecting at Ally.
Yeah - my emergency fund is a little lower than I am comfortable with. But, my expenses are also lower (though not by the same proportion).

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Church Lady » Thu Apr 20, 2017 5:38 pm

I will probably carry my 3% mortgage into retirement -- about ten years to pay off if I let the mortgage it run its course. The after tax rate is a little more than 2%. If I felt I couldn't beat a 2% after tax return on my savings/investments, it would be time to pay off the mortgage. That's a pretty low hurdle!

If in future I can't itemize, I will have to ask myself whether I can beat 3% with my investments, with low risk.

Of course, paying the mortgage adds thousands of dollars to my cash flow needs. As I draw closer to age 63, I will examine my actual cash flows and see if I am in danger of exceeding the current Medicare Tier 1 income level. If so, it might make sense to pay off or recast the mortgage to keep my income below that level. I'll work that out when the time comes.

For young folks in early retirement, it might make sense to keep cash flow needs low to qualify for Medicaid or an ACA premium subsidy.

If you're paying PMI, then YES it makes sense to pre-pay to get rid of PMI!

Long term housing deflation (think Japan) might be a reason to consider an early payoff.

I'm no expert; just some thoughts. Good luck with your decision!
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by billthecat » Thu Apr 20, 2017 6:30 pm

Pranav wrote:I maximize my contributions to tax-advantaged accounts and then throw the leftover income towards the mortgage.


I do the same and I focus on paying down ARMs even though the (current) rate is below my fixed rate mortgages (indeed, they're rising as they reset annually).

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by wolf359 » Thu Apr 20, 2017 6:54 pm

To me, it doesn't make sense to PAY DOWN a low-rate mortgage. It may make sense to PAY OFF the mortgage.

Paying off the mortgage will reduce your expenses. If you're about to early retire, this is useful.

Paying down the mortgage buys you nothing. Your mortgage payments (monthly expenses) remain the same.

During accumulation mode, I'd keep the historically low 3% mortgage as long as I could, even into retirement if I could afford it. I believe that 20 years from now, a 3% mortgage will be a fantasy. (If I'm wrong, and we're down to 1% mortgages, then I'll refinance.)

I am investing the funds to keep liquidity, better enabling early retirement. One of the first milestones is to have my taxable account sufficiently large to pay off the mortgage all at once. By the time I retire, I'll be able to choose whether or not to pay off the mortgage or continue to let it ride. Partly this is because of the amount of time it will take to accumulate the retirement funds, during which time the mortgage will be paid down naturally.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by billthecat » Thu Apr 20, 2017 6:57 pm

wolf359 wrote:To me, it doesn't make sense to PAY DOWN a low-rate mortgage. It may make sense to PAY OFF the mortgage.

Paying off the mortgage will reduce your expenses. If you're about to early retire, this is useful.

Paying down the mortgage buys you nothing. Your mortgage payments (monthly expenses) remain the same.

During accumulation mode, I'd keep the historically low 3% mortgage as long as I could, even into retirement if I could afford it. I believe that 20 years from now, a 3% mortgage will be a fantasy. (If I'm wrong, and we're down to 1% mortgages, then I'll refinance.)

I am investing the funds to keep liquidity, better enabling early retirement. One of the first milestones is to have my taxable account sufficiently large to pay off the mortgage all at once. By the time I retire, I'll be able to choose whether or not to pay off the mortgage or continue to let it ride. Partly this is because of the amount of time it will take to accumulate the retirement funds, during which time the mortgage will be paid down naturally.


If you pay down a fixed rate mortgage, you could have it recast to reduce your payments. Or refinance.

But even if you don't change the payments, you are reducing your expenses (the interest) even if you're not changing the cash flow.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by 10YearPlan » Thu Apr 20, 2017 7:05 pm

Right now my strategy is to slowly chip away at the balance by paying extra each month, but it's not going to get me to paid off status unless I get more aggressive. That being said...my answer, for now:

When the mortgage balance is at a point where I can pay it off while still maintaining an adequate cash reserve and without significantly impacting my taxable portfolio/investments. In other words, if I can pay off from cash or without a huge spend down of the portfolio, then I will consider writing that payoff check. In practice this means it has to be a pretty low balance or I have to have a lot of money invested. Maybe both.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by mesaverde » Thu Apr 20, 2017 7:08 pm

wolf359 wrote:To me, it doesn't make sense to PAY DOWN a low-rate mortgage. It may make sense to PAY OFF the mortgage.

Paying off the mortgage will reduce your expenses. If you're about to early retire, this is useful.

Paying down the mortgage buys you nothing. Your mortgage payments (monthly expenses) remain the same.

During accumulation mode, I'd keep the historically low 3% mortgage as long as I could, even into retirement if I could afford it. I believe that 20 years from now, a 3% mortgage will be a fantasy. (If I'm wrong, and we're down to 1% mortgages, then I'll refinance.)

I am investing the funds to keep liquidity, better enabling early retirement. One of the first milestones is to have my taxable account sufficiently large to pay off the mortgage all at once. By the time I retire, I'll be able to choose whether or not to pay off the mortgage or continue to let it ride. Partly this is because of the amount of time it will take to accumulate the retirement funds, during which time the mortgage will be paid down naturally.


This is exactly what I'm doing and I have a 2.5% fixed rate mortgage. It's nice to have liquid investments and the option of using those liquid investments to pay off the mortgage. To me liquidity and options are win-win, not to mention the likelihood that the liquid investment will earn a higher rate of return, even after the possibility of long term capital gains tax.
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Dottie57 » Thu Apr 20, 2017 7:13 pm

1) if the mortgage worries you start putting more money in.
2).if paying it off is better than savings rate at bank or bonds.
3) if you want to.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Artsdoctor » Thu Apr 20, 2017 7:23 pm

panhead wrote:The question of whether or not to pay down a mortgage is a staple on this and many other sites, as we are all very aware, so I hope this question is different enough that it doesn't go down the same rabbit hole.

So, the question is, if you have a low rate mortgage (say 3% in todays environment) Is there a threshold when it makes more sense to prioritize paying off the mortgage rather than continue to invest? I ask this primarily from the viewpoint of someone who is still in accumulation mode who is considering early retirement. Let's assume a mid 40s to mid 50s person.
Possible answers:

1) (X) times expenses in investments
2) The above with (Y) times investments easily accessible (ie, in taxable)
3) When bond rates are lower than the after-tax cost of your mortgage
4) When Jupiter is in retrograde
5) ???

The usual question usually gets a response of "I'd invest" or "I'd pay off the mortgage" this question is trying to figure out if there is a factor or series of factors that would make paying down the mortgage more of a priority than investing. The answer could be anything, qualitative or quantitative, just looking for perspective.
Note, at retirement, I believe most of us would want a paid off mortgage, that is why I took this as someone who is still in accumulation mode.

Anyway, what do you think?


There are hundreds of ways to look at this, and it's rarely black and white. Inevitably, it's going to come down to personal preference since there are too many variables.

I prize flexibility and love having options. My mortgage rate is 2.75% and the "after-tax" rate is about 1.6%, at least for 2016. I'm not eager to pay it off and am happily biding my time because I enjoy having the flexibility of putting the money elsewhere--but knowing I can pay off the whole balance easily whenever I want. That point will come in early 2019 when I'm anticipating retiring altogether. It's an arbitrary line and it's really only based in history: it feels right to enter "retirement" without a mortgage. However, I fully appreciate that one could make a very, very good argument for keeping that low-rate mortgage for as long as possible.

Although I really love our house, I view it as a very, very illiquid--and fickle--asset. As it stands now, I won't see any of that money that was used to purchase the house until I sell it, and I'm not anticipating doing that until it's no longer possible to live here.

So in answer to your question, I would loosely say this: I wouldn't pay off the mortgage unless you won't really miss the mortgage amount in your portfolio (your house will hopefully make up less of your portfolio as you get older), or unless you're going to stop the income stream.

This is a topic that can be discussed indefinitely.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by grabiner » Thu Apr 20, 2017 7:53 pm

I would suggest paying down a mortgage when that is the best use of your money; that is, it gives the best risk-adjusted return.

To find the risk-adjusted return, compare the after-tax rate on your mortgage to the after-tax rate on a low-risk bond of the same duration as your mortgage prepayments. For example, I have 12 years left on my mortgage. If I made a single extra mortgage payment, that would have an 12-year duration, as I would be locking in that rate for 12 years; a fair comparison would be a 12-year bond. If I could pay the whole thing off, that would have a 6-year duration, as it would eliminate payments from 1 month to 12 years.

I normally use municipal bonds for comparison. While paying down the mortgage is risk-free, and munis are not quite risk-free, there is also the issue of giving up the option by paying down the mortgage. That is, if I don't pay off my mortgage this year, and rates fall, I can choose to pay off my mortgage next year when it is more profitable. If I do pay off my mortgage this year, and rates risk, I cannot choose to take the mortgage back out at the original rate.

For example, my mortgage rate is 2.625%, which is 1.89% after tax in my 28% bracket. Municipal bonds with a six-year duration yield 2.36% (average of Vanguard Intermediate-Term and Long-Term Tax-Exempt Admiral yields). Therefore, even if I had enough cash to pay off my mortgage now, I wouldn't do it; I would prefer to invest in those funds. (I actually don't invest in those funds; I hold bonds in my retirement account and stocks in my taxable account.)

But suppose that when there are ten years left on my mortgage, yields on Vanguard Intermediate-Term Tax-Exempt drop to 1.75% from the current 2.05%. Now, if I have enough money to pay off the whole mortgage, I will do it, as I would rather earn 1.89% with a five-year duration on the mortgage than 1.75% on five-year bonds. But it still wouldn't be worth selling stock for a large capital gain to make the mortgage payment.
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by MoonOrb » Thu Apr 20, 2017 8:23 pm

It makes a lot more sense to me as retirement age approaches and some of these things happen:

1. You're maxing out all tax advantaged accounts, including making catch up contributions
2. You have no other debt to pay off instead
3. You may no longer be in a position to itemize tax deductions
4. You want to reduce your expenses during retirement so that you can increase your opportunity to do Roth conversions during early retirement years (because you have lower annual expenses you need to withdraw less from retirement accounts, increasing probability that you can have years of low tax liability, providing greater opportunity for Roth conversion).
5. Interest rates are still sufficiently low so that paying off the mortgage is an attractive alternative to lower risk options

When you're in the accumulation phase it seems to make much less sense to me because you have less immediate need for cash and a longer time horizon in which to invest. The longer your time horizon is the more likely you are to beat the return you'd get by paying down the debt.

Also, if inflation pushes up the yield on lower risk investments and drives up mortgage rates, you'll wish you had kept your mortgage at its now very low rate. If, on the other hand, mortgage interest rates go even lower, you can always refinance.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by rick0 » Thu Apr 20, 2017 8:42 pm

Reinforcing what MoonOrb says, I started seriously paying my mortgage down when:
- My kids college expenses were pretty much covered.
- I started to look forwards to retirement in 5 years or so.

I wanted to simplify and lower baseline expenses in retirement,
and in fact retired about 6 months after the mortgage went away!

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by wolf359 » Fri Apr 21, 2017 8:38 am

As I stated before, I don't believe it makes sense to pay down a low rate mortgage. It's better to have liquidity, and to invest the money for better returns.

There is one extra factor that I'm facing that will influence my decision about whether or not I pay off the mortgage when I'm nearing retirement. My mortgage is actually timed to be close to payoff around the time my kids are projected to go to college. I already have their college paid for with 529 plans should they choose to go to state schools. Should they both go to more expensive private colleges, I may pay off the remaining mortgage balance, freeing up the cash flow to pay for tuition (combining it with the 529 balances). I won't have enough details to make a decision until closer to that time, because it depends on how my kids do academically, where they end up going to school, what tuition assistance they get, and what my financial situation is at the time.

So although I believe it's better to hold to a historically low-rate mortgage as long as possible, I think it makes sense to let it go if the income stream used to pay it is better applied somewhere else. (This assumes you have an income stream that is covering the mortgage.)

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by ryman554 » Fri Apr 21, 2017 8:46 am

billthecat wrote:
If you pay down a fixed rate mortgage, you could have it recast to reduce your payments. Or refinance.

But even if you don't change the payments, you are reducing your expenses (the interest) even if you're not changing the cash flow.


You won't recast when contributing an extra $100 or so a month vs. investing. You've got to have a big chunk paid down before you can do this.

At the point where I am at today -- I can kill about 30% of my mortgage using the money I'm targeting to pay off the mortgage currently invested in my taxable account. I am seriously looking at using that and recasting and or refi to 7/1 is very enticing, but the loss of the "second tier emergency fund" is giving me pause.

Basically, if equities return 1-2% nominal (not real), I don't really come out ahead by paying down and recasting, assuming continued savings rates. I suspect most others will see the same: if they can save enough to make a large enough dent in their mortgage, it's likely that not pre-paying is usually the optimal strategy even for below-average economic times.

Reducing cash-flow is good and very enticing, but so it a big bolus of money that can help you support the larger cash flow. I struggle with the correct decision.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Admiral » Fri Apr 21, 2017 10:07 am

I have about 14.5 years left on a 15 year 2.25% fixed rate mortgage. It will be about paid off (or close) when I plan to stop working full time. The mortgage payment is about 18% of our after tax income (after all tax-advantaged accounts are maxed) so it's not a large financial burden.

No way would or will I pay it off early unless I get a HUGE windfall. There's no point. After-tax it's practically free money. (OK not really, but close. With inflation, it kind of is.)

One way I look at it is that each month, 3/4 of my payment goes to principal. In my case, that's about $1450/month, and of course it goes up a tad each month. That's real savings on the balance sheet (debt reduction), even if it's illiquid. So in a sense this money is still being "invested" (it increases net worth) it's just not in the markets. I'm below 50% LTV and plan to keep on keepin' on.

If you can make more in bonds, then I would never pay it off. And even if you can't, hopefully you can beat a 3% pre-tax return, otherwise why are we all in this game in the first place??

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by avalpert » Fri Apr 21, 2017 11:01 am

I really don't understand the 'pay it off to free up cash flow' reasoning - if you have the cash to pay it off you don't need it to flow.

I kind of understand the 'forced savings' reasoning if you need it, but there are ways to force savings into investment accounts to so it still doesn't make a good argument for paying off the mortgage.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Admiral » Fri Apr 21, 2017 11:09 am

avalpert wrote:I really don't understand the 'pay it off to free up cash flow' reasoning - if you have the cash to pay it off you don't need it to flow.


I think the point with this argument (which I don't support either) is that one would be liquidating investments to pay off the mortgage. Investments are distinct from monthly cash flow, i.e. your salary that goes to pay the mortgage and other bills. Once the mortgage is gone, the former money used for P+I goes back into an investment account.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by avalpert » Fri Apr 21, 2017 11:12 am

Admiral wrote:
avalpert wrote:I really don't understand the 'pay it off to free up cash flow' reasoning - if you have the cash to pay it off you don't need it to flow.


I think the point with this argument (which I don't support either) is that one would be liquidating investments to pay off the mortgage. Investments are distinct from monthly cash flow, i.e. your salary that goes to pay the mortgage and other bills. Once the mortgage is gone, the former money used for P+I goes back into an investment account.


Yeah, I get that is what they are saying - it just doesn't make sense beyond a form of mental accounting (maybe if it were costly to sell investments per sales event so you were better off making a large single sale to get the cash out at once - but that is an edge case that in this day and age I think would be quite rare).

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by TheJoker » Fri Apr 21, 2017 11:19 am

Someone please explain why you would pay down or off a 3 or 4% mortgage when the long term 500 index will return you 7% ? Invest at 7% and forget the interest on a 4% mortgage.

Admiral
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Admiral » Fri Apr 21, 2017 11:23 am

BhamETFs wrote:Someone please explain why you would pay down or off a 3 or 4% mortgage when the long term 500 index will return you 7% ? Invest at 7% and forget the interest on a 4% mortgage.


Says who? That's the historical average, not a guaranteed return. Since paying off a mortgage is a guaranteed return equal to the interest rate, one needs to compare the rate to a similar vehicle: bonds, CDs, or T bills (or a savings account... remember those days??)

That said, most people seems to feel they can beat a low mortgage rate by investing.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Chip » Fri Apr 21, 2017 11:24 am

BhamETFs wrote:Someone please explain why you would pay down or off a 3 or 4% mortgage when the long term 500 index will return you 7% ? Invest at 7% and forget the interest on a 4% mortgage.


The short answer is risk. Stock market returns aren't guaranteed but the mortgage is a guaranteed debt.

If you are 100% stocks and want to leverage your portfolio for a higher expected return (at higher risk), then keeping the mortgage might make sense.

But let me ask you this question: If you're NOT at 100% stocks, why would you buy a bond fund yielding 2% while also paying 3-4% on a mortgage?

P.S. The S&P 500 has returned 7% (or something like that) IN THE PAST. You are conflating past performance with the future when you say "500 index will return you 7%". There are no guarantees going forward.
Last edited by Chip on Fri Apr 21, 2017 11:26 am, edited 1 time in total.

Admiral
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Admiral » Fri Apr 21, 2017 11:25 am

Chip wrote:
But let me ask you this question: If you're NOT at 100% stocks, why would you buy a bond fund yielding 2% while also paying 3-4% on a mortgage?


That's an easy answer:

Liquidity.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by Chip » Fri Apr 21, 2017 11:29 am

Admiral wrote:That's an easy answer:

Liquidity.


I can understand the liquidity reason, but most of these posts are about return differentials. And many of them come from people who also own bonds.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by whodidntante » Fri Apr 21, 2017 11:50 am

I'm not a fan of paying down a low rate mortgage. And I don't. There is a cash flow benefit to paying off that may help you realize less taxable income in retirement.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by mortfree » Fri Apr 21, 2017 12:09 pm

BhamETFs wrote:Someone please explain why you would pay down or off a 3 or 4% mortgage when the long term 500 index will return you 7% ? Invest at 7% and forget the interest on a 4% mortgage.


3% interest on a 300,000 mortgage vs 7% potential earnings of what amount?

So you need to have maybe 150,000 invested to break even on mortgage interest vs investment earnings.

Yes, over time the mortgage balance will decrease and the invested amount should increase... but where is that break even point???

can you really overcome all of that mortgage interest from early on in the loan terms with your investment?
Last edited by mortfree on Fri Apr 21, 2017 12:14 pm, edited 1 time in total.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by avalpert » Fri Apr 21, 2017 12:13 pm

mortfree wrote:
BhamETFs wrote:Someone please explain why you would pay down or off a 3 or 4% mortgage when the long term 500 index will return you 7% ? Invest at 7% and forget the interest on a 4% mortgage.


3% interest on a 300,000 mortgage vs 7% potential earnings of what amount?

So you need to have maybe 150,000 invested to break even on mortgage interest vs investment earnings.

Yes, over time the mortgage balance will decrease and the invested amount should increase... but where is that break even point???


There is no breakeven point - for any given dollar it will always be worth more to earn 7% on it then pay down debt that is accruing interest at 3%. This of course ignores the risk associated with obtaining the 7% return or the 3% interest over any defined period of time.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by an_asker » Fri Apr 21, 2017 12:15 pm

Asking questions like that here will likely get you a 51-49 split, and you will be exactly where you started!! Instead ...

I read this trick somewhere, and it is worth taking a shot. It works whenever you're faced with an option 1 vs. option 2 choice.

Take a quarter - assign an option to each side, say heads = option 1 and tails = option 2.

Flip the coin.

- let's say you get heads (option 1). How do you feel - happy or unhappy? If you are happy, go ahead with option 1, else option 2.
- let's say you get tails (option 2). How do you feel - happy or unhappy? If you are happy, go ahead with option 2, else option 1.

Try it ...

PS: I hope folks don't use this method in the polling booth ;-)

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by DaftInvestor » Fri Apr 21, 2017 12:18 pm

Answer: #4

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by panhead » Fri Apr 21, 2017 12:20 pm

OP here, thank you for all of the replies, it has given me many more things to think about. My personal situation is a 3% mortgage on a very small mortgage that probably doesn't make much difference whether I pay it off or not, but I still think about it a lot, guess I like mental gymnastics. I've asked about my personal situation before and agreed with grabiner that investing in muni funds was a better bet, and that's pretty much what I've been doing, though I have been paying it down at a 15 year rate instead of a 30 year, so yeah, I'm throwing some extra money in there too.

The idea of keeping income lower for ACA subsidies or to do Roth conversions sure makes sense, but this is stuff most of us will be doing when retired, not during accumulation.

Again, thank you for all the well crafted replies, there were several things there I hadn't contemplated before....

Edited to add: I also jumped on the NWFCU 3% CD with an amount almost exactly equal to my mortgage....so yeah, I guess I like liquidity too, at least for now! Now, when it comes due in 2018 I'll have another decision to make!

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by DaftInvestor » Fri Apr 21, 2017 12:35 pm

panhead wrote:OP here, thank you for all of the replies, it has given me many more things to think about. My personal situation is a 3% mortgage on a very small mortgage that probably doesn't make much difference whether I pay it off or not, but I still think about it a lot, guess I like mental gymnastics. I've asked about my personal situation before and agreed with grabiner that investing in muni funds was a better bet, and that's pretty much what I've been doing, though I have been paying it down at a 15 year rate instead of a 30 year, so yeah, I'm throwing some extra money in there too.

The idea of keeping income lower for ACA subsidies or to do Roth conversions sure makes sense, but this is stuff most of us will be doing when retired, not during accumulation.

Again, thank you for all the well crafted replies, there were several things there I hadn't contemplated before....

Edited to add: I also jumped on the NWFCU 3% CD with an amount almost exactly equal to my mortgage....so yeah, I guess I like liquidity too, at least for now! Now, when it comes due in 2018 I'll have another decision to make!


Its hard to beat a 3% Guaranteed return so there is nothing wrong with paying your mortgage down even at the low rate of 3%. Some say "what about the tax deduction" - you will be paying income tax on your 3% CD as well - so the tax benefits come out even as well. Some like the liquidity of holding their cash (e.g. buying your 3% CD) while others have like the peace of mind of being debt free (e.g. paying off the 3% mortgage).

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by panhead » Fri Apr 21, 2017 12:52 pm

DaftInvestor wrote:
panhead wrote:OP here, thank you for all of the replies, it has given me many more things to think about. My personal situation is a 3% mortgage on a very small mortgage that probably doesn't make much difference whether I pay it off or not, but I still think about it a lot, guess I like mental gymnastics. I've asked about my personal situation before and agreed with grabiner that investing in muni funds was a better bet, and that's pretty much what I've been doing, though I have been paying it down at a 15 year rate instead of a 30 year, so yeah, I'm throwing some extra money in there too.

The idea of keeping income lower for ACA subsidies or to do Roth conversions sure makes sense, but this is stuff most of us will be doing when retired, not during accumulation.

Again, thank you for all the well crafted replies, there were several things there I hadn't contemplated before....

Edited to add: I also jumped on the NWFCU 3% CD with an amount almost exactly equal to my mortgage....so yeah, I guess I like liquidity too, at least for now! Now, when it comes due in 2018 I'll have another decision to make!


Its hard to beat a 3% Guaranteed return so there is nothing wrong with paying your mortgage down even at the low rate of 3%. Some say "what about the tax deduction" - you will be paying income tax on your 3% CD as well - so the tax benefits come out even as well. Some like the liquidity of holding their cash (e.g. buying your 3% CD) while others have like the peace of mind of being debt free (e.g. paying off the 3% mortgage).


Yes, I agree completely. A 3% mortgage and a 3% CD will balance each other out, the tax advantage on the mortgage doesn't make the CD better as you have to pay tax on that anyway....now if it was a 4% CD.....!

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by billthecat » Wed Apr 26, 2017 11:31 am

panhead wrote:
DaftInvestor wrote:
panhead wrote:OP here, thank you for all of the replies, it has given me many more things to think about. My personal situation is a 3% mortgage on a very small mortgage that probably doesn't make much difference whether I pay it off or not, but I still think about it a lot, guess I like mental gymnastics. I've asked about my personal situation before and agreed with grabiner that investing in muni funds was a better bet, and that's pretty much what I've been doing, though I have been paying it down at a 15 year rate instead of a 30 year, so yeah, I'm throwing some extra money in there too.

The idea of keeping income lower for ACA subsidies or to do Roth conversions sure makes sense, but this is stuff most of us will be doing when retired, not during accumulation.

Again, thank you for all the well crafted replies, there were several things there I hadn't contemplated before....

Edited to add: I also jumped on the NWFCU 3% CD with an amount almost exactly equal to my mortgage....so yeah, I guess I like liquidity too, at least for now! Now, when it comes due in 2018 I'll have another decision to make!


Its hard to beat a 3% Guaranteed return so there is nothing wrong with paying your mortgage down even at the low rate of 3%. Some say "what about the tax deduction" - you will be paying income tax on your 3% CD as well - so the tax benefits come out even as well. Some like the liquidity of holding their cash (e.g. buying your 3% CD) while others have like the peace of mind of being debt free (e.g. paying off the 3% mortgage).


Yes, I agree completely. A 3% mortgage and a 3% CD will balance each other out, the tax advantage on the mortgage doesn't make the CD better as you have to pay tax on that anyway....now if it was a 4% CD.....!


In my case, I'm paying mortgages on rental properties. They're at about 4% (I'm paying down the ARMs). I'm doing that, instead of investing, because risk-free 4% is better to me than 7% potentially subject to taxes today at 45%.

The 4% would also be subject to taxes if paying down the mortgages increased my taxable income. It does not, in my case, both due to current write-offs and a backlog of PALCOs. It does, howver, increase my cash flow each time the ARMs reset (built in recasting essentially).

And, given that they are ARMs, if I invested instead then I would be exposed to volatility on two sides, interest rate increases and market volatility.

So, for me, paying down the rental ARMs increases my income without increasing my taxes, increases my cash flow, and reduces risk.
Last edited by billthecat on Thu Apr 27, 2017 12:30 am, edited 1 time in total.

chipperd
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by chipperd » Wed Apr 26, 2017 6:15 pm

Since a 3% mortgage is probably around 2.25% after the deduction, I would never pay that sucker off.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by noco-hawkeye » Wed Apr 26, 2017 8:29 pm

I had a related post, and I think #1 and #2 certainly have some impact. If you've found that you are mostly financially independent, but still have a mortgage - then you really aren't independent.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by avalpert » Wed Apr 26, 2017 8:45 pm

noco-hawkeye wrote:I had a related post, and I think #1 and #2 certainly have some impact. If you've found that you are mostly financially independent, but still have a mortgage - then you really aren't independent.


How is someone with a $7 million investment portfolio, $200k/expense (including mortgage payment) and a $500k mortgage at 2.5% less financially independent then someone with $6.5 million investment portfolio $175k/expense and no mortgage?

The existence of a mortgage in and of itself is not indicative of financial (in)dependence.

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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by JDCarpenter » Wed Apr 26, 2017 10:16 pm

noco-hawkeye wrote:I had a related post, and I think #1 and #2 certainly have some impact. If you've found that you are mostly financially independent, but still have a mortgage - then you really aren't independent.


Huh? Our mortgage balance could be paid at any time (well, give me a week to transfer some funds around) and the monthly payment is less than 10% of our planned retirement spending. Every month we pay more on credit cards than on mortgage--by your theory, wouldn't we need to pay credit cards in advance of charges, otherwise, we "really aren't independent?"
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Re: When does it make sense to start paying down (or off) a low rate mortgage?

Post by TheHouse7 » Thu Apr 27, 2017 8:18 am

I think it is really interesting how some don't consider debt as risk. Probably ringing their hands about their AA bonds/stocks for the next downturn while they make a 1-3% spread on their investments off what could be paying down debt. The costs are guaranteed in your loan; the gains from investment are not.

Think about the amount your spread is from paying down a mortgage vs. bond gains; and then tell me that's how everyone gets rich. :confused
"PSX will always go up 20%, why invest in anything else?!" -Father-in-law early retired.

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