pay down mortgage or invest in taxable

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jessikaur
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pay down mortgage or invest in taxable

Post by jessikaur » Wed Dec 13, 2017 8:04 am

Hello all,

I'm trying to decide whether I should pay down a 30 year fixed mortgage at 3.875 with about 550K left on a 1M home that I plan on living in forever; or invest in my taxable account?

I already contribute max to two 401ks, hsa, 2 back door roths (for my and my spouse), ... all other debts have ostensibly been paid off. so it would just be where excess income goes..


my thoughts are this: I should contribute to my taxable until I reach my financial goals for retirement, then use the income earned in this account to pay down the house whenever this goal is reached, but I just want to make sure I'm thinking about it the right way..

I know we're not supposed to "time" the market, but my other thought was since the market is doing very well right now, it might be time to pay down debts, and then when we have a market correction to start investing at that point (although, I still would be investing with all of the retirement accounts) so this was kind of a way to hedge my bets??

Thanks!!

The Wizard
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Re: pay down mortgage or invest in taxable

Post by The Wizard » Wed Dec 13, 2017 8:10 am

I would do some of both: pay a few hundred more on the mortgage each month and put the rest into taxable investments.

And while it might be good to have a dollar amount goal for your investment accounts, you can't really be too confident about it until you are within a few years of retirement. Things tend to evolve...
Last edited by The Wizard on Wed Dec 13, 2017 8:15 am, edited 1 time in total.
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KlangFool
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Re: pay down mortgage or invest in taxable

Post by KlangFool » Wed Dec 13, 2017 8:11 am

jessikaur wrote:
Wed Dec 13, 2017 8:04 am
Hello all,

I'm trying to decide whether I should pay down a 30 year fixed mortgage at 3.875 with about 550K left on a 1M home that I plan on living in forever; or invest in my taxable account?

I already contribute max to two 401ks, hsa, 2 back door roths (for my and my spouse), ... all other debts have ostensibly been paid off. so it would just be where excess income goes..


my thoughts are this: I should contribute to my taxable until I reach my financial goals for retirement, then use the income earned in this account to pay down the house whenever this goal is reached, but I just want to make sure I'm thinking about it the right way..

I know we're not supposed to "time" the market, but my other thought was since the market is doing very well right now, it might be time to pay down debts, and then when we have a market correction to start investing at that point (although, I still would be investing with all of the retirement accounts) so this was kind of a way to hedge my bets??

Thanks!!
jessikaur,

<< my thoughts are this: I should contribute to my taxable until I reach my financial goals for retirement, then use the income earned in this account to pay down the house whenever this goal is reached, >>

I would invest in the taxable until I reach my retirement goal. At that time, if it is worthwhile for me to pay off the mortgage in one lump sum, I would do that. Or else, I won't. I would not pre-pay the mortgage's principal. It is easy to beat the 3.875% interest rate with typical portfolio return rate.

KlangFool

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Re: pay down mortgage or invest in taxable

Post by KlangFool » Wed Dec 13, 2017 8:14 am

OP,

Do you have kids? Do you plan to pay for their college education? In your case, invest in 529 may make sense.

KlangFool

Da5id
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Re: pay down mortgage or invest in taxable

Post by Da5id » Wed Dec 13, 2017 8:30 am

jessikaur wrote:
Wed Dec 13, 2017 8:04 am
Hello all,

I'm trying to decide whether I should pay down a 30 year fixed mortgage at 3.875 with about 550K left on a 1M home that I plan on living in forever; or invest in my taxable account?

I already contribute max to two 401ks, hsa, 2 back door roths (for my and my spouse), ... all other debts have ostensibly been paid off. so it would just be where excess income goes..


my thoughts are this: I should contribute to my taxable until I reach my financial goals for retirement, then use the income earned in this account to pay down the house whenever this goal is reached, but I just want to make sure I'm thinking about it the right way..

I know we're not supposed to "time" the market, but my other thought was since the market is doing very well right now, it might be time to pay down debts, and then when we have a market correction to start investing at that point (although, I still would be investing with all of the retirement accounts) so this was kind of a way to hedge my bets??

Thanks!!
There is a bogleheads wiki page that discusses this and may have some points you find interesting:
But note at the top the link to the talk page, apparently this is not really agreed on. I personally find the idea of paying it down if the effective yield (after deduction) is better than the yield of the fixed income investment you might make as an alternative intuitive and compelling. But you do lose liquidity (HELOC may or may not be available to you?).

stan1
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Re: pay down mortgage or invest in taxable

Post by stan1 » Wed Dec 13, 2017 8:34 am

We made one extra payment a year for about 10 years, two extra payments a year for about 5 years, then eventually paid off our mortgage. Having a six figure taxable account gives you liquidity to make decisions that come up in life without having to take out a loan or postpone something important to you because you have to "save up".

Jack FFR1846
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Re: pay down mortgage or invest in taxable

Post by Jack FFR1846 » Wed Dec 13, 2017 10:04 am

This comes down to risk. Since you're getting nothing in need based financial aid, you'd want to determine if you're ok with upcoming potential market downturns. If you are, then sure....invest in a taxable account. If seeing your account go to half what it is now would turn your stomach or worse, make you sell, then pay the mortgage.

I'll note that I paid my mortgage as part of my avalanche payment of all debt.....probably before the term was even coined. I'll say that having a paid off mortgage for 15 years has given me zero regret. Having that $0 mortgage payment for the first several months is like winning the Irish Sweepstakes every month. Like swimming in extra cash.
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DaftInvestor
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Re: pay down mortgage or invest in taxable

Post by DaftInvestor » Wed Dec 13, 2017 10:18 am

As KlangFool mentioned; if you have kids and plan to pay for their college putting money in a 529 is a great way to get tax-free growth.
If that isn't the case - I would do a bit of both - put a little into taxable monthly towards retirement (enough to meet retirement goals assuming you are DCA'ing the same amount monthly throughout your career) then the rest toward the mortgage.
If the current market valuation makes you too nervous to invest in taxable, iBonds are another consideration as they can serve as a second-tier Emergency Fund (if you are concerned about losing employment and want to expand your EF) while at the same time providing tax-deferred interest. Although if you were going to do this the current interest rates don't quite beat (depending upon your post-tax returns) simply paying more toward your mortgage.

WageSlave
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Re: pay down mortgage or invest in taxable

Post by WageSlave » Wed Dec 13, 2017 2:46 pm

jessikaur wrote:
Wed Dec 13, 2017 8:04 am
I already contribute max to two 401ks, hsa, 2 back door roths (for my and my spouse), ... all other debts have ostensibly been paid off. so it would just be where excess income goes.
And an appropriately-sized liquid emergency fund, right? (E.g. six months' living expenses in a checking account.)

Be careful when comparing your mortgage rate against investment returns: be sure to think about risk. Paying off a mortgage is a guaranteed return on the interest you would otherwise pay; no risk. There are no zero- or even low-risk investments that guarantee 3.875%... US Treasuries are among the safest investments, but they're not paying anywhere near that.

This is a fairly frequently asked question; a little searching will yield numerous results discussing many aspects of the decision. But to summarize how I looked at it: once you have all the "basics" covered (as you do), then keeping a mortgage is like leverage for your investment portfolio; similar to a margin account, but with better terms. Leverage basically exaggerates your portfolio performance: gains or losses. But, long-term, most BH-style portfolios of the past have gained, and we're all banking on some kind of future gains. So based on that rationale, keeping a mortgage while investing isn't a bad idea.

Also, in the USA, there is a tax write-off for mortgage interest. If you have enough deductions to itemize, the write-off effectively reduces your mortgage rate by your marginal tax rate. For the last few years I had a mortgage, I was was easily in itemization territory, so the effective mortgage rate I was paying was less than what I was earning on the bond portion of my portfolio. (Still not apples to apples in terms of risk, but the bonds were lower risk than stocks.)

Having said all that... I chose to payoff my mortgage. The above thoughts and the math exercises I did said that keeping the mortgage was the way to greater wealth. But in the end, I wanted to "buy" the good feelings that come with having a house completely paid off. This is the first time in my life since moving out of my parents' house that I've had no rent or mortgage. It's a great feeling.

One potential downside to paying off the mortgage: I've splurged on some luxuries a few times since the payoff---nothing outrageous or anything like that, but I've since found my attitude on personal finance tilted a bit more to the indulgent side of things. Definitely no regrets, but I didn't think I'd have to re-affirm my commitment to modest living.

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Re: pay down mortgage or invest in taxable

Post by grabiner » Wed Dec 13, 2017 10:00 pm

jessikaur wrote:
Wed Dec 13, 2017 8:04 am
I'm trying to decide whether I should pay down a 30 year fixed mortgage at 3.875 with about 550K left on a 1M home that I plan on living in forever; or invest in my taxable account?
If you want to make extra payments on the mortgage (which isn't unreasonable), you might want to refinance it to 15 years at a lower rate; you'll pay less in interest while paying it down.

my thoughts are this: I should contribute to my taxable until I reach my financial goals for retirement, then use the income earned in this account to pay down the house whenever this goal is reached, but I just want to make sure I'm thinking about it the right way.
This is not the right way to think of it, because paying down the mortgage also helps your goals in retirement. If you retire with $200K still owed on the house, you will have to get that $200K from your retirement savings, in addition to covering your living expenses. Conversely, if you pay off the mortgage before you retire, the money that was otherwise going to mortgage payments will become additional money you can save for retirement, with no decline in your standard of living.

Effectively, paying down the mortgage is a risk-free long-term investment yielding 3.875%; you have to decide whether that is a better investment than other things you can do. At current yields, if you are in the 33% tax bracket which is likely for someone owning a home that expensive, you would earn 2.60% after tax on mortgage payments, and you could earn 2.47% on Admiral shares of Vanguard Long-Term Tax-Exempt with a shorter duration.
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Watty
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Re: pay down mortgage or invest in taxable

Post by Watty » Wed Dec 13, 2017 10:11 pm

One option would be to save up the money until you have maybe 10 or 20 percent of the loan balance then check with your lender to ask if they will "recast your mortgage" (Google this). They are not required to but they usually will for a processing fee of a couple of hundred of dollars. The way this works is if you pay it down by 20% then your required monthly payment would be reduced by the same percentage. Your interest rate and an lenght of the mortgage would stay the same. That could be important if interest rates go up or something happens like you are laid off.

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badbreath
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Re: pay down mortgage or invest in taxable

Post by badbreath » Wed Dec 13, 2017 10:59 pm

Refinance to a 15 Year and pay off in 15 years vs 30 that's what I did
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Re: pay down mortgage or invest in taxable

Post by Goal33 » Thu Dec 14, 2017 1:40 am

What are your liquidity needs?

Can you get a lower rate going to a 15 year loan? Maybe that's a good compromise.

I invest in my taxable -- and it's not because I think I can beat my 3.5% interest rate, I actually don't expect that. It is because I want to have access to cash if I need it.
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heybro
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Re: pay down mortgage or invest in taxable

Post by heybro » Thu Dec 14, 2017 1:55 am

The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.

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Re: pay down mortgage or invest in taxable

Post by Cruise » Thu Dec 14, 2017 3:32 am

heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
Yes!

OP: about 7 years ago, I. Had a windfall that I chose to use to payoff my mortgage. Had I invested that windfall, I would be in better financial shape (S&P500 increase), but is only a consequence of unknowables at the the time. However, I am so glad I paid off that mortgage. The peace of mind is priceless. And, guess what we did with our money slated for our monthly payments? Invest. A win win.

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Re: pay down mortgage or invest in taxable

Post by Da5id » Thu Dec 14, 2017 8:02 am

heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
Feels like an emotional answer, IMHO. Yes, I have my mortgage paid off and like the feeling. So if we want the feel good answer, OK. But whether it is wise to pay down a mortgage is situational, not unconditional as your post would imply. And if (as a short term issue) I needed to take a little home equity out to get a 401k match, I'd do it...

heybro
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Re: pay down mortgage or invest in taxable

Post by heybro » Mon Dec 18, 2017 2:36 am

Da5id wrote:
Thu Dec 14, 2017 8:02 am
heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
Feels like an emotional answer, IMHO. Yes, I have my mortgage paid off and like the feeling. So if we want the feel good answer, OK. But whether it is wise to pay down a mortgage is situational, not unconditional as your post would imply. And if (as a short term issue) I needed to take a little home equity out to get a 401k match, I'd do it...
I never said a person should pay off their mortgage because it feels good. I was making a point that people do not generally take out mortgages on homes they already own for the sole reason of funding a retirement account. I agree with you that everything depends on a person's situation or the situation. I think this question will be answered the same time we settle rent vs buy and how-much-international. haha.

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Re: pay down mortgage or invest in taxable

Post by pdanet » Mon Dec 18, 2017 1:11 pm

jessikaur wrote:
Wed Dec 13, 2017 8:04 am

I'm trying to decide whether I should pay down a 30 year fixed mortgage at 3.875 with about 550K left on a 1M home that I plan on living in forever; or invest in my taxable account?

I already contribute max to two 401ks, hsa, 2 back door roths (for my and my spouse), ... all other debts have ostensibly been paid off
Depends. What is your annual house hold income?

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Re: pay down mortgage or invest in taxable

Post by BrandonBogle » Mon Dec 18, 2017 2:01 pm

Op, given you are otherwise investing, your can't go wrong either way. Sure one may be slightly more financially-beneficial than the other, but it wouldn't be major either way and you'll "succeed" even with the lower earnings, so you should honestly do what feels best - be that invest first, mortgage first, or a mix of the two. "Don't sweat the small stuff" now that you already are set up to win the game regardless of your decision with this extra funds.

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Re: pay down mortgage or invest in taxable

Post by Da5id » Mon Dec 18, 2017 2:04 pm

DaftInvestor wrote:
Wed Dec 13, 2017 10:18 am
As KlangFool mentioned; if you have kids and plan to pay for their college putting money in a 529 is a great way to get tax-free growth.
If you have kids with college coming any time soon, paying down mortgage can also be good plan. Home equity doesn't apply for parental assets for FAFSA, though it does for CSS.

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DaftInvestor
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Re: pay down mortgage or invest in taxable

Post by DaftInvestor » Mon Dec 18, 2017 2:49 pm

Da5id wrote:
Mon Dec 18, 2017 2:04 pm
DaftInvestor wrote:
Wed Dec 13, 2017 10:18 am
As KlangFool mentioned; if you have kids and plan to pay for their college putting money in a 529 is a great way to get tax-free growth.
If you have kids with college coming any time soon, paying down mortgage can also be good plan. Home equity doesn't apply for parental assets for FAFSA, though it does for CSS.
Although the vast majority of folks that can afford to pay down their mortgage won't get anything from FAFSA. If the OP can afford a 1M home - there is little chance FAFSA/CSS will do anything for him.

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Re: pay down mortgage or invest in taxable

Post by ThePrince » Mon Dec 18, 2017 3:01 pm

heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
+1

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Re: pay down mortgage or invest in taxable

Post by Nate79 » Mon Dec 18, 2017 3:04 pm

Would you borrow money at 3.875% to invest in the taxable account? If not pay off the mortgage.

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Re: pay down mortgage or invest in taxable

Post by ThePrince » Mon Dec 18, 2017 3:07 pm

Da5id wrote:
Thu Dec 14, 2017 8:02 am
heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
Feels like an emotional answer, IMHO. Yes, I have my mortgage paid off and like the feeling. So if we want the feel good answer, OK. But whether it is wise to pay down a mortgage is situational, not unconditional as your post would imply. And if (as a short term issue) I needed to take a little home equity out to get a 401k match, I'd do it...
Emotional? Nope. A logical answer? Yes. If you invest money instead of paying off your mortgage, you're effectively borrowing that mortgage money to invest in the stock market. It's a sunk cost analysis.

Da5id
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Re: pay down mortgage or invest in taxable

Post by Da5id » Mon Dec 18, 2017 3:16 pm

ThePrince wrote:
Mon Dec 18, 2017 3:07 pm
Da5id wrote:
Thu Dec 14, 2017 8:02 am
heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
Feels like an emotional answer, IMHO. Yes, I have my mortgage paid off and like the feeling. So if we want the feel good answer, OK. But whether it is wise to pay down a mortgage is situational, not unconditional as your post would imply. And if (as a short term issue) I needed to take a little home equity out to get a 401k match, I'd do it...
Emotional? Nope. A logical answer? Yes. If you invest money instead of paying off your mortgage, you're effectively borrowing that mortgage money to invest in the stock market. It's a sunk cost analysis.
Say you are comparing paying the mortgage off to investing in bonds instead, as that is a closer comparison. Seems like the decision involved is dependent on the mortgage rate and the fixed income rate. I believe having your mortgage paid off "feels good". Mine is paid off, it feels good. But the decision of whether one should pay off a mortgage is mostly a matter of comparing the alternatives for which has a better expected return (and considering risks) rather than going for the good feeling.

My understanding of sunk costs are that they are irrecoverable past costs that shouldn't rationally change your decision making. How does that possibly apply to this scenario? You can pay off your mortgage. You can take money out of your house and do things with it. What cost is sunk?

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Re: pay down mortgage or invest in taxable

Post by ThriftyPhD » Mon Dec 18, 2017 3:21 pm

heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
Not a good metric, you're leading to confirmation bias.
1. People who have made the decision in the past to do this are going to be the type of person who would value being debt free over maximizing net worth.
2. People tend to justify their past decisions to feel better about them.

On top of that, plenty of people mortgage their home to pay for retirement.

https://www.bogleheads.org/wiki/Reverse_mortgages
The number of reverse mortgages dropped from an annual peak of about 115,000 in 2009 to 30,000 in 2016
In the end, it comes down to balancing the value of liquidity vs the value of being debt free. A guess as to how the market will perform over the life of your mortgage relative to the interest rate you're paying. Lots of personal decisions that makes it a unique calculation for each situation.

Here is a thought for the OP.

If the plan is to live in the home forever, do you plan on renovating at any point? Does it make sense to pay down $100k of mortgage over the next 5 years, and then take out a $100k HELOC in 5 years for the reno, or to save the $100k over 5 years to pay for the reno outright? Depends on what you think HELOC rates will be in 5 years compared to your mortgage rate. Even this scenario you would need to adjust the $100k and 5 year values to what your plan is.

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Re: pay down mortgage or invest in taxable

Post by Admiral » Mon Dec 18, 2017 3:24 pm

ThePrince wrote:
Mon Dec 18, 2017 3:07 pm
Da5id wrote:
Thu Dec 14, 2017 8:02 am
heybro wrote:
Thu Dec 14, 2017 1:55 am
The way I answer this question is this:

Walk up to any guy who owns his house free and clear and ask him if he'd like to take a mortgage out on that house in order to use the money for a retirement account. I don't think anyone would say yes.
Feels like an emotional answer, IMHO. Yes, I have my mortgage paid off and like the feeling. So if we want the feel good answer, OK. But whether it is wise to pay down a mortgage is situational, not unconditional as your post would imply. And if (as a short term issue) I needed to take a little home equity out to get a 401k match, I'd do it...
Emotional? Nope. A logical answer? Yes. If you invest money instead of paying off your mortgage, you're effectively borrowing that mortgage money to invest in the stock market. It's a sunk cost analysis.
That's one way to think about it, sure. Here's another way:

Your house may need a new roof
You may have unexpected medical expenses
You may get sick
Your spouse may get sick
You may lose your job
Your spouse may lose his or her job
Your kids may pick a pricey college

And if you put all your spare cash into your house, you will pay for these things with... what? A home equity loan? Great, so you'll subject yourself to unknown interest rate risk (and soon to be non-deductible interest!) for a loan against your biggest asset in the future? How is that a good plan?

If one has significant non-tax-sheltered reserves for all of life's eventualities, then yes. If not--and many people don't--then you're entering a liquidity trap.

To OP: If you have the money for added payments and are set on doing something, consider a 15 year refi: less interest. Though I don't know what current 15 year rates are.

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Re: pay down mortgage or invest in taxable

Post by jessikaur » Tue Dec 19, 2017 10:43 am

Thank you everyone for the great responses.

To answer some of the questions

1) we do not have kids, I'm 36, and I'm sure my husband and I will NOT be taking the leap. enjoy a life of luxury travel together. so, likely will not need the 528 plans, although that would've been awesome.
2) I have about 150K in my taxable account already for liquidity purposes.
3) we already did a 268K house reno that I cash-flowed with my multiple jobs.
4) the way i think about this mortgage, and you guys correct me if it's the wrong way to think about it.. is that 3.875 is fairly low for a jumbo mortgage,i itemize our taxes, and we do get the interest rate deduction, plus if i keep this mortgage for the life of the term (30 years, ends in 2041) i will be paying that mortgage in today's dollars (so we also get the inflation benefit)
5) I have no emotional problems with debt, it doesn't bother me as long as we can make our monthly payments.
6) I think the compound interest from the investments will outperform this mortgage simple interest.
7) we live in florida, sp we defintiely have the homestead advantage, so dumping all the money into the house also provides a benefit, but i would like to do this when I'm in a "danger" situation of being sued..

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Re: pay down mortgage or invest in taxable

Post by CurlyDave » Tue Dec 19, 2017 12:59 pm

heybro wrote:
Mon Dec 18, 2017 2:36 am
... I was making a point that people do not generally take out mortgages on homes they already own for the sole reason of funding a retirement account. I agree with you that everything depends on a person's situation or the situation. I think this question will be answered the same time we settle rent vs buy and how-much-international. haha.
Well, I may be that rare bird. I had the option to pay off the mortgage on our retirement home when our home in a HCOL area sold almost 6 years ago.

I chose to invest the money, and have never regretted it for an instant.

Of course, I am a risk-taker and have a much more active retirement than most...

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Re: pay down mortgage or invest in taxable

Post by voodoo72 » Tue Dec 19, 2017 1:43 pm

CurlyDave wrote:
Tue Dec 19, 2017 12:59 pm
heybro wrote:
Mon Dec 18, 2017 2:36 am
... I was making a point that people do not generally take out mortgages on homes they already own for the sole reason of funding a retirement account. I agree with you that everything depends on a person's situation or the situation. I think this question will be answered the same time we settle rent vs buy and how-much-international. haha.
Well, I may be that rare bird. I had the option to pay off the mortgage on our retirement home when our home in a HCOL area sold almost 6 years ago.

I chose to invest the money, and have never regretted it for an instant.

Of course, I am a risk-taker and have a much more active retirement than most...
Just curious , do you think you would feel the same if we weren't in a 8 year bull market?

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Re: pay down mortgage or invest in taxable

Post by lolbatross » Tue Dec 19, 2017 3:17 pm

jessikaur wrote:
Tue Dec 19, 2017 10:43 am
6) I think the compound interest from the investments will outperform this mortgage simple interest.
I agree.

Often lost on here is that your fixed rate should be compared against the nominal cumulative average growth rate - not real. The overall historical numbers are about 9%. The worst 30 year nominal cagr has never been below 4%. In fact if you started in 2000(ouch) through 2016 (not counting 2017) you would be at 4.5% nominal cagr. You would be only slightly ahead at this point - and by slightly I mean a total of 40% ahead.

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Re: pay down mortgage or invest in taxable

Post by kaudrey » Tue Dec 19, 2017 3:21 pm

badbreath wrote:
Wed Dec 13, 2017 10:59 pm
Refinance to a 15 Year and pay off in 15 years vs 30 that's what I did
+1

CurlyDave
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Re: pay down mortgage or invest in taxable

Post by CurlyDave » Tue Dec 19, 2017 3:35 pm

voodoo72 wrote:
Tue Dec 19, 2017 1:43 pm
...Just curious , do you think you would feel the same if we weren't in a 8 year bull market?
Yes. I like to keep the odds in my favor.

And my portfolio is a "back up emergency fund". If i pay off a mortgage the money is gone. If I invest it and someone develops an expensive medical problem, or anything unforeseen happens, my ability to borrow again may be severely diminished, but if I have the money, or the assets, in hand it can be used for many purposes.

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Re: pay down mortgage or invest in taxable

Post by victw » Tue Dec 19, 2017 3:47 pm

jessikaur wrote:
Wed Dec 13, 2017 8:04 am
Hello all,

I'm trying to decide whether I should pay down a 30 year fixed mortgage at 3.875 with about 550K left on a 1M home that I plan on living in forever; or invest in my taxable account?

I already contribute max to two 401ks, hsa, 2 back door roths (for my and my spouse), ... all other debts have ostensibly been paid off. so it would just be where excess income goes..

Thanks!!
How do you define excess income... What percentage of your income are you saving?

Vic

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Re: pay down mortgage or invest in taxable

Post by voodoo72 » Tue Dec 19, 2017 4:44 pm

CurlyDave wrote:
Tue Dec 19, 2017 3:35 pm
voodoo72 wrote:
Tue Dec 19, 2017 1:43 pm
...Just curious , do you think you would feel the same if we weren't in a 8 year bull market?
Yes. I like to keep the odds in my favor.

And my portfolio is a "back up emergency fund". If i pay off a mortgage the money is gone. If I invest it and someone develops an expensive medical problem, or anything unforeseen happens, my ability to borrow again may be severely diminished, but if I have the money, or the assets, in hand it can be used for many purposes.
Gotcha, that makes sense, reason I ask like the OP, I go back and forth with this , I recently paid off my practice loan, so now there is a chunk I can use to invest or throw at mortgage to speed up repayment, but still not sure, as you stated not so easy to liquidate equity in a home. This has been a god mental exercise for me.

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Re: pay down mortgage or invest in taxable

Post by dave_k » Tue Dec 19, 2017 5:31 pm

I considered this question several months ago, and because of the tax deductibility of the interest and our tax bracket, I came to the conclusion that it was better to invest in municipal bonds in taxable rather than pay down the mortgage. In our case we will likely sell the house in about 5 years, so I roughly matched the duration of the bonds to that time-frame to make them comparable, and with the bond yields at the time it was better to buy the bonds.

In your case, since you would be paying down a 30 year mortgage without wanting to move ever, you would effectively be locking the money up for longer. That may make longer term and better-yielding bonds more comparable if you want to go with bonds (more of a "sure bet" than stocks as an alternative to paying off the mortgage), or if it's purely retirement investment, go according to your AA if you're willing to add risk.

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Re: pay down mortgage or invest in taxable

Post by limine » Tue Dec 19, 2017 7:09 pm

I've struggled with this question as well (good problem to have, obviously). The essentially unscientific answer I came to was that we should split the difference, weighting toward investing. We have a more-than-adequate emergency fund, and I'm comfortable with our liquidity. Because of that, we put 80% of any "excess" money into our taxable account, according to our desired allocation, and 20% to our mortgage. The 80/20 divide was honestly somewhat arbitrary.

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Re: pay down mortgage or invest in taxable

Post by Ketawa » Tue Dec 19, 2017 8:07 pm

lolbatross wrote:
Tue Dec 19, 2017 3:17 pm
jessikaur wrote:
Tue Dec 19, 2017 10:43 am
6) I think the compound interest from the investments will outperform this mortgage simple interest.
I agree.

Often lost on here is that your fixed rate should be compared against the nominal cumulative average growth rate - not real. The overall historical numbers are about 9%. The worst 30 year nominal cagr has never been below 4%. In fact if you started in 2000(ouch) through 2016 (not counting 2017) you would be at 4.5% nominal cagr. You would be only slightly ahead at this point - and by slightly I mean a total of 40% ahead.
I don't think I've ever seen anyone on the "pay down mortgage" side conclude that paying it down is better by mistakenly comparing a nominal interest rate to real returns, thereby making the mortgage rate look good by comparison. In fact, people on the other side often make this mistake. They say their mortgage rate is below inflation, therefore it's a good deal. Who cares about inflation when real rates are low on everything?

Interest rates were a lot higher in 2000, so your 4.5% comparison isn't meaningful.

The 30 year Treasury yield is below 3%. Treasuries of shorter duration are lower than 3%. Why would anyone investing for retirement bother with fixed income when they're "guaranteed" to do better.

As others have pointed out in this thread and as is described in the wiki article, the appropriate comparison is to fixed income investments. Rather than only choosing between:

A1. paying down a mortgage
A2. investing in taxable

...you can also choose between:

B1. paying down a mortgage and leaving asset allocation unchanged
B2. paying down a mortgage and increasing allocation to equities

B2 is often more efficient than A2 because you avoid investing in a taxable account, depending on the particular circumstances. It also has benefits for things like college financial aid, where home equity is not counted for many public schools. Simply looking at stock market returns is not the best way to approach this question.

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Re: pay down mortgage or invest in taxable

Post by lolbatross » Wed Dec 20, 2017 11:14 am

Who cares about inflation when real rates are low on everything?
Inflation matters because when it comes to a mortgage it is on your side. Historically inflation is around 3.3%. Recently is less than 2% - say 1.4% cagr for 2012-2016. In this case given the mortgage rate, tax benefit and inflation OP needs to get 2% real to keep up. If inflation increases OP needs even less real performance to keep up. So inflation matters because it benefits you.
Interest rates were a lot higher in 2000, so your 4.5% comparison isn't meaningful.
Fair point - I failed to make my intended point.
The 30 year Treasury yield is below 3%. Treasuries of shorter duration are lower than 3%. Why would anyone investing for retirement bother with fixed income when they're "guaranteed" to do better.
Depends on the time frame. At 30 years I wouldn't invest in fixed income much if at all. At 10 I would. I think generally is in line with the BH AA philosophy.
B2 is often more efficient than A2 because you avoid investing in a taxable account,
Tax drag is often stated on here as 1%. For me 25% of slightly less than 2% yield on equities is 0.4%. Perhaps its biased by my personal assumptions, but the typical tax drag number here is 2.5x my observed value. For op it may be higher depending on tax bracket.
Simply looking at stock market returns is not the best way to approach this question.
I agree, but it also can not be ignored or understated.

I appreciate that this forum allows for discussion and dissenting opinions. Without that it would be an echo chamber. While I get the psychological allure of pay down a mortgage I don't see it as the correct theoretical decision. Tweaks to assumptions (see tax drag, expected returns!) of course can change this answer. The conservative decision is not one to be ashamed of, but understand the opportunity lost.

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Re: pay down mortgage or invest in taxable

Post by johnbarry » Thu Dec 21, 2017 12:18 am

lolbatross wrote:
Wed Dec 20, 2017 11:14 am
While I get the psychological allure of pay down a mortgage I don't see it as the correct theoretical decision.
What theory are you referring to? Standard finance theory (CAPM) would say that if your mortgage is above the risk free rate (which it is for everyone) then paying it off generates positive alpha, which is all the rage in investment banking circles. You can of course borrow above the risk free rate and invest in an index fund, but this is guaranteed to give you negative alpha. It may be OK for some people, but no investment banker would make such a bet and expect to keep their job.

Maybe there is a different theory applicable to personal finance and how to trade off risk and returns there that I am unaware of, but I've been reading the forum for a while and haven't come across one. Would love to know about it though...

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Re: pay down mortgage or invest in taxable

Post by grabiner » Thu Dec 21, 2017 12:33 am

johnbarry wrote:
Thu Dec 21, 2017 12:18 am
lolbatross wrote:
Wed Dec 20, 2017 11:14 am
While I get the psychological allure of pay down a mortgage I don't see it as the correct theoretical decision.
What theory are you referring to? Standard finance theory (CAPM) would say that if your mortgage is above the risk free rate (which it is for everyone) then paying it off generates positive alpha, which is all the rage in investment banking circles.
Because of the tax laws, your mortgage may be below the risk-free rate for the same duration. If you have 10 years left on your 3% mortgage which is 2% after tax, and 10-year Treasury bonds earn 2.5%, you can earn a risk-free 10-year return of 2% by paying down your mortgage, or 2.5% by buying Treasury bonds in your Roth IRA if you aren't maxing it out.

Even in a taxable account, you may be generating alpha in a high tax bracket, because you can deduct your mortgage interest but earn tax-free income on municipal bonds. Munis aren't quite risk-free, but the risk premium may be worth it (and you could adjust for the risk by changing other investments to be less risky, such as selling corporate bonds to buy Treasuries).
Wiki David Grabiner

johnbarry
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Re: pay down mortgage or invest in taxable

Post by johnbarry » Thu Dec 21, 2017 12:53 am

grabiner wrote:
Thu Dec 21, 2017 12:33 am
Because of the tax laws, your mortgage may be below the risk-free rate for the same duration. If you have 10 years left on your 3% mortgage which is 2% after tax, and 10-year Treasury bonds earn 2.5%, you can earn a risk-free 10-year return of 2% by paying down your mortgage, or 2.5% by buying Treasury bonds in your Roth IRA if you aren't maxing it out.
Good point, re: risk free rate. However, you should think about after-tax returns in taxable in that case, or use both numbers before tax so that you are comparing apples to apples.

I like the point people make on the forum regarding muni bonds and others. Intuitively some of these decisions maybe even feel right to me. But I just don't see the theory that properly considers risk and returns in that situation. It could be just that the theory is lacking, but that the BHs have it right...

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Re: pay down mortgage or invest in taxable

Post by spitty » Thu Dec 21, 2017 7:50 am

When I started prepaying my mortgage, one of the reasons was to keep my grubby little paws off the money. Investing those dollars instead of prepaying makes it available to buy that extra little luxury you otherwise wouldn't splurge on--new car, boat, etc. Another angle if you think you may not have the discipline to leave those appreciated funds alone. We're mortgage free for over 10 years and it's a great feeling!
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Re: pay down mortgage or invest in taxable

Post by riverguy » Thu Dec 21, 2017 8:06 am

grabiner wrote:
Thu Dec 21, 2017 12:33 am
johnbarry wrote:
Thu Dec 21, 2017 12:18 am
lolbatross wrote:
Wed Dec 20, 2017 11:14 am
While I get the psychological allure of pay down a mortgage I don't see it as the correct theoretical decision.
What theory are you referring to? Standard finance theory (CAPM) would say that if your mortgage is above the risk free rate (which it is for everyone) then paying it off generates positive alpha, which is all the rage in investment banking circles.
Because of the tax laws, your mortgage may be below the risk-free rate for the same duration. If you have 10 years left on your 3% mortgage which is 2% after tax, and 10-year Treasury bonds earn 2.5%, you can earn a risk-free 10-year return of 2% by paying down your mortgage, or 2.5% by buying Treasury bonds in your Roth IRA if you aren't maxing it out.

Even in a taxable account, you may be generating alpha in a high tax bracket, because you can deduct your mortgage interest but earn tax-free income on municipal bonds. Munis aren't quite risk-free, but the risk premium may be worth it (and you could adjust for the risk by changing other investments to be less risky, such as selling corporate bonds to buy Treasuries).
Pretty much no one is going to be taking the mortgage deduction anymore with SALT deduction fixed at $10k and the standard deduction at $24k.
Last edited by riverguy on Thu Dec 21, 2017 9:56 am, edited 1 time in total.

lolbatross
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Re: pay down mortgage or invest in taxable

Post by lolbatross » Thu Dec 21, 2017 9:40 am

johnbarry wrote:
Thu Dec 21, 2017 12:18 am
lolbatross wrote:
Wed Dec 20, 2017 11:14 am
While I get the psychological allure of pay down a mortgage I don't see it as the correct theoretical decision.
What theory are you referring to? Standard finance theory (CAPM) would say that if your mortgage is above the risk free rate (which it is for everyone) then paying it off generates positive alpha, which is all the rage in investment banking circles. You can of course borrow above the risk free rate and invest in an index fund, but this is guaranteed to give you negative alpha. It may be OK for some people, but no investment banker would make such a bet and expect to keep their job.

Maybe there is a different theory applicable to personal finance and how to trade off risk and returns there that I am unaware of, but I've been reading the forum for a while and haven't come across one. Would love to know about it though...
Under CAPM isn't investing instead of paying down a mortgage mostly increasing beta with minimal impact (depending on rate) to alpha?

The worst 30 years in the stock market still had average cagr of ~8% nominal. A mortgage is not callable -thus no risk of ruin for investments along the way due to "leverage". Averages closure to 10%. Obviously I can't predict the future and there is a non zero chance of under performance. That being said the spread is substantial.

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Re: pay down mortgage or invest in taxable

Post by NextMil » Thu Dec 21, 2017 10:54 am

I agonize over this issue with a 2.9% mortgage on a 15year fixed with 10 years to go. I have finally come to the conclusion that I split my excess cash between principal reductions and taxable, and then I find a thread like this and start the process over of beating up myself over my decision in both directions. The mental struggle between risk v. reward on this is really taxing. Cannot wait for the day its paid off and I don't have to second guess my decision ever again.

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Re: pay down mortgage or invest in taxable

Post by lolbatross » Thu Dec 21, 2017 11:09 am

NextMil wrote:
Thu Dec 21, 2017 10:54 am
I agonize over this issue with a 2.9% mortgage on a 15year fixed with 10 years to go. I have finally come to the conclusion that I split my excess cash between principal reductions and taxable, and then I find a thread like this and start the process over of beating up myself over my decision in both directions. The mental struggle between risk v. reward on this is really taxing. Cannot wait for the day its paid off and I don't have to second guess my decision ever again.
Your time frame on your mortgage is 10 years. I think this changes the equation substantially. Your split the difference approach is reasonable. Instead of flipping the coin 30 times you are doing it 10 times. Substantial difference!

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Re: pay down mortgage or invest in taxable

Post by NextMil » Thu Dec 21, 2017 11:13 am

Thx. That is helpful to hear.

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Re: pay down mortgage or invest in taxable

Post by johnbarry » Thu Dec 21, 2017 11:25 am

NextMil wrote:
Thu Dec 21, 2017 10:54 am
I agonize over this issue with a 2.9% mortgage on a 15year fixed with 10 years to go. I have finally come to the conclusion that I split my excess cash between principal reductions and taxable, and then I find a thread like this and start the process over of beating up myself over my decision in both directions. The mental struggle between risk v. reward on this is really taxing. Cannot wait for the day its paid off and I don't have to second guess my decision ever again.
You can look at this in a glass half-full way too: your approach is certainly half-right, I (and others) may be 100% wrong.

NextMil
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Re: pay down mortgage or invest in taxable

Post by NextMil » Thu Dec 21, 2017 12:08 pm

johnbarry wrote:
Thu Dec 21, 2017 11:25 am
NextMil wrote:
Thu Dec 21, 2017 10:54 am
I agonize over this issue with a 2.9% mortgage on a 15year fixed with 10 years to go. I have finally come to the conclusion that I split my excess cash between principal reductions and taxable, and then I find a thread like this and start the process over of beating up myself over my decision in both directions. The mental struggle between risk v. reward on this is really taxing. Cannot wait for the day its paid off and I don't have to second guess my decision ever again.
You can look at this in a glass half-full way too: your approach is certainly half-right, I (and others) may be 100% wrong.
Thanks. That is sort of where I ended up. Diversifying the risk and reward. I think in the end if/when my investments overtake the remainder of the mortgage, it will be tough not to liquidate and pay it all off, but in the meantime, I have some non-retirement "liquidity" should I need to draw on some investments while still accelerating the payoff.

Its also a good reminder that all of us are working toward financial independence, so either way, we are still ahead of 99% of our peers in personal finance without sounding like we are resting on our laurels.

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