Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction

 Posts: 317
 Joined: Sun Dec 29, 2013 3:10 pm
Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
As a long time Dave Ramsey follower, I was pretty set in my ways that my wife and I would plan to pay down the mortgage instead of invest the aftertax dollars in index funds. Now I think I'm actually about to turn a new leaf.
*Our historical tax deductions are pretty much limited to property tax ($14K) and mortgage interest (<$14K). I'm assuming we'll claim the new standard $24K deduction in 2018 instead of itemizing, since our property tax is now capped at $10K.
We have a 4.125%, $340K mortgage on a $500K home with 26 years left. For at least the next several years, it looks like we will have at least $20K annually to either put towards mortgage principal or invest in aftertax index funds.
I ran an excel analysis over this 26 year period assuming an aftertax investment growth rate of 6%. Here are the results I achieved for both scenarios....
Scenario 1: First 10 years all money goes towards principal, house gets paid off, and annual investments of $40K kick in ($20K + an additional 20K that previously went to the mortgage), starting in year 11 and lasting through year 26. On three separate occasions in the first 10 years, I assumed we would need to kick in an extra 10K, so an extra $30K was added. When I consider 16 years of after tax investments, the total sum comes to $1.027M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $0.969M
Scenario 2: First 10 years we contribute $20K annually plus the extra $30K described in scenario 1. From year 11  year 26, we continue investing 20K annually as we continue to pay our mortgage. The total sum comes to $1.282M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $1.166.
So it does indeed seem that even with paying the bank on a longer mortgage, I would in theory come out well ahead by keeping the mortgage. I also like that this money would be more accessible should it be needed. Anyway, any thoughts are welcome, but I do think this decision seems to be an individual preference call.
*Our historical tax deductions are pretty much limited to property tax ($14K) and mortgage interest (<$14K). I'm assuming we'll claim the new standard $24K deduction in 2018 instead of itemizing, since our property tax is now capped at $10K.
We have a 4.125%, $340K mortgage on a $500K home with 26 years left. For at least the next several years, it looks like we will have at least $20K annually to either put towards mortgage principal or invest in aftertax index funds.
I ran an excel analysis over this 26 year period assuming an aftertax investment growth rate of 6%. Here are the results I achieved for both scenarios....
Scenario 1: First 10 years all money goes towards principal, house gets paid off, and annual investments of $40K kick in ($20K + an additional 20K that previously went to the mortgage), starting in year 11 and lasting through year 26. On three separate occasions in the first 10 years, I assumed we would need to kick in an extra 10K, so an extra $30K was added. When I consider 16 years of after tax investments, the total sum comes to $1.027M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $0.969M
Scenario 2: First 10 years we contribute $20K annually plus the extra $30K described in scenario 1. From year 11  year 26, we continue investing 20K annually as we continue to pay our mortgage. The total sum comes to $1.282M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $1.166.
So it does indeed seem that even with paying the bank on a longer mortgage, I would in theory come out well ahead by keeping the mortgage. I also like that this money would be more accessible should it be needed. Anyway, any thoughts are welcome, but I do think this decision seems to be an individual preference call.
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
Well as Dave Ramsey would tell you, you aren't factoring in risk.
I have read on here that the best way to do this analysis is to compare paying off your mortgage to a similar investment in terms of risk. Grabiner (I think that is his handle) he knows the most about this stuff. But I think I recall him saying you need to compare paying off your mortgage to buying bond funds of similar duration. Sorry I can't be of much help but I know this for sure, you are comparing apples and oranges.
I have read on here that the best way to do this analysis is to compare paying off your mortgage to a similar investment in terms of risk. Grabiner (I think that is his handle) he knows the most about this stuff. But I think I recall him saying you need to compare paying off your mortgage to buying bond funds of similar duration. Sorry I can't be of much help but I know this for sure, you are comparing apples and oranges.
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
The after tax investment returns of 6% are pretty optimistic, IMO. Is that 100% stocks, or a 80/20 or 60/40 mix of stocks/bonds?
Personally, I'd take the guranteed rate of the mortgage and call it good. But, there are many different feelings on that and it's a personal decision.
Personally, I'd take the guranteed rate of the mortgage and call it good. But, there are many different feelings on that and it's a personal decision.

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 Joined: Thu Apr 05, 2007 8:20 pm
 Location: New York
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
Are you 100% invested in small value emerging markets equities? If not, you might want to revise your 6% aftertax return.
Hard to see how you arrive at 10%+ returns when the best minds in the business are optimistically calculating 45% real. Show us the way you think you'll earn 6% aftertax.
Hard to see how you arrive at 10%+ returns when the best minds in the business are optimistically calculating 45% real. Show us the way you think you'll earn 6% aftertax.
"One should invest based on their need, ability and willingness to take risk  Larry Swedroe" Asking Portfolio Questions
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
As others have said, an after tax return of 6% is probably not realistic. Also, you are comparing a risky return of stocks and bonds vs a no risk return of paying off a mortgage.PlayingLife wrote: ↑Thu Mar 01, 2018 1:50 pmAs a long time Dave Ramsey follower, I was pretty set in my ways that my wife and I would plan to pay down the mortgage instead of invest the aftertax dollars in index funds. Now I think I'm actually about to turn a new leaf.
*Our historical tax deductions are pretty much limited to property tax ($14K) and mortgage interest (<$14K). I'm assuming we'll claim the new standard $24K deduction in 2018 instead of itemizing, since our property tax is now capped at $10K.
We have a 4.125%, $340K mortgage on a $500K home with 26 years left. For at least the next several years, it looks like we will have at least $20K annually to either put towards mortgage principal or invest in aftertax index funds.
I ran an excel analysis over this 26 year period assuming an aftertax investment growth rate of 6%. Here are the results I achieved for both scenarios....
Scenario 1: First 10 years all money goes towards principal, house gets paid off, and annual investments of $40K kick in ($20K + an additional 20K that previously went to the mortgage), starting in year 11 and lasting through year 26. On three separate occasions in the first 10 years, I assumed we would need to kick in an extra 10K, so an extra $30K was added. When I consider 16 years of after tax investments, the total sum comes to $1.027M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $0.969M
Scenario 2: First 10 years we contribute $20K annually plus the extra $30K described in scenario 1. From year 11  year 26, we continue investing 20K annually as we continue to pay our mortgage. The total sum comes to $1.282M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $1.166.
So it does indeed seem that even with paying the bank on a longer mortgage, I would in theory come out well ahead by keeping the mortgage. I also like that this money would be more accessible should it be needed. Anyway, any thoughts are welcome, but I do think this decision seems to be an individual preference call.
I am typically not one to push people to pay off mortgage but if you are at over 4% with no tax deduction it is worth considering IF you fully fund all retirement account opportunities and IF you otherwise have ample liquidity.
Here are some other alternatives to consider:
1. Can you refinance to 15 years to something in the 3% range with low upfront fees?
2. Split the difference, You could choose to put half down on your mortgage and the other half in an after tax portfolio.
3. If you choose to payoff mortgage, increase your asset allocation more towards stocks in a retirement accounts. Paying off your mortgage is similar to investing in a risk free bond.

 Posts: 317
 Joined: Sun Dec 29, 2013 3:10 pm
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
I think there's a misunderstanding here. When I say 6%, I mean I am calculating my aftertax contributions to grow 6% annually, knowing that the gains will be taxed once they are withdrawn. Here is my calculation used in excel...Grt2bOutdoors wrote: ↑Thu Mar 01, 2018 2:09 pmAre you 100% invested in small value emerging markets equities? If not, you might want to revise your 6% aftertax return.
Hard to see how you arrive at 10%+ returns when the best minds in the business are optimistically calculating 45% real. Show us the way you think you'll earn 6% aftertax.
Year 1 = +20,000
Year 2 = (20,000 * 1.06) + 20,000
Year 3 = (Year 2 * 1.06) + 20,000,
and so on, until I reach a lump sum.
Lump sum = total contributions + gains
Realized gains = gains * 0.85
Total cash after all taxes = Lump Sum + Realized Gains
Is this a ridiculous calculation? I don't mind being challenged,I prefer to be challenged to fully understand both sides. Investments would mirror my retirement investments...Vanguard total stock [60] / Vanguard total intl [20] / Vanguard bond [20]
The one big argument I did have in favor of paying down the house is that 4.125% is high enough for me to carefully consider. Wish I bought a year later as I could have gotten 3.5%.

 Posts: 317
 Joined: Sun Dec 29, 2013 3:10 pm
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
Those alternatives are interesting, thank you for sharing this. I did look at a couple of online interest quotes but I'm not so sure I can refinance to a low enough rate to make it worth it. Fees do add up quick too, in my state you are legally obligated to hire legal assistance. Option 2 and 3 are very interesting, thanks.JBTX wrote: ↑Thu Mar 01, 2018 2:14 pmAs others have said, an after tax return of 6% is probably not realistic. Also, you are comparing a risky return of stocks and bonds vs a no risk return of paying off a mortgage.PlayingLife wrote: ↑Thu Mar 01, 2018 1:50 pmAs a long time Dave Ramsey follower, I was pretty set in my ways that my wife and I would plan to pay down the mortgage instead of invest the aftertax dollars in index funds. Now I think I'm actually about to turn a new leaf.
*Our historical tax deductions are pretty much limited to property tax ($14K) and mortgage interest (<$14K). I'm assuming we'll claim the new standard $24K deduction in 2018 instead of itemizing, since our property tax is now capped at $10K.
We have a 4.125%, $340K mortgage on a $500K home with 26 years left. For at least the next several years, it looks like we will have at least $20K annually to either put towards mortgage principal or invest in aftertax index funds.
I ran an excel analysis over this 26 year period assuming an aftertax investment growth rate of 6%. Here are the results I achieved for both scenarios....
Scenario 1: First 10 years all money goes towards principal, house gets paid off, and annual investments of $40K kick in ($20K + an additional 20K that previously went to the mortgage), starting in year 11 and lasting through year 26. On three separate occasions in the first 10 years, I assumed we would need to kick in an extra 10K, so an extra $30K was added. When I consider 16 years of after tax investments, the total sum comes to $1.027M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $0.969M
Scenario 2: First 10 years we contribute $20K annually plus the extra $30K described in scenario 1. From year 11  year 26, we continue investing 20K annually as we continue to pay our mortgage. The total sum comes to $1.282M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $1.166.
So it does indeed seem that even with paying the bank on a longer mortgage, I would in theory come out well ahead by keeping the mortgage. I also like that this money would be more accessible should it be needed. Anyway, any thoughts are welcome, but I do think this decision seems to be an individual preference call.
I am typically not one to push people to pay off mortgage but if you are at over 4% with no tax deduction it is worth considering IF you fully fund all retirement account opportunities and IF you otherwise have ample liquidity.
Here are some other alternatives to consider:
1. Can you refinance to 15 years to something in the 3% range with low upfront fees?
2. Split the difference, You could choose to put half down on your mortgage and the other half in an after tax portfolio.
3. If you choose to payoff mortgage, increase your asset allocation more towards stocks in a retirement accounts. Paying off your mortgage is similar to investing in a risk free bond.
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
Or a cross between 2 and 3. You put part of your monthly savings into stocks only (ignoring bonds). The rest you use to pay off mortgage. As a general rule most bonds are not terribly tax efficient in a taxable account anyway, as interest is taxed at regular rates, not capital gains rates. Paying off a 4% + mortgage that is not tax deductible will almost certainly give you a better return than a bond fund and you have no tax consequences. An after tax return of a bond fund will probably be in the 2.02.5% range vs 4.125% impact of paying off mortgage. Paying off mortgage is probably even better than after tax return of bonds in a tax deferred account (2.5% to 3.0%).PlayingLife wrote: ↑Thu Mar 01, 2018 4:03 pmThose alternatives are interesting, thank you for sharing this. I did look at a couple of online interest quotes but I'm not so sure I can refinance to a low enough rate to make it worth it. Fees do add up quick too, in my state you are legally obligated to hire legal assistance. Option 2 and 3 are very interesting, thanks.JBTX wrote: ↑Thu Mar 01, 2018 2:14 pmAs others have said, an after tax return of 6% is probably not realistic. Also, you are comparing a risky return of stocks and bonds vs a no risk return of paying off a mortgage.PlayingLife wrote: ↑Thu Mar 01, 2018 1:50 pmAs a long time Dave Ramsey follower, I was pretty set in my ways that my wife and I would plan to pay down the mortgage instead of invest the aftertax dollars in index funds. Now I think I'm actually about to turn a new leaf.
*Our historical tax deductions are pretty much limited to property tax ($14K) and mortgage interest (<$14K). I'm assuming we'll claim the new standard $24K deduction in 2018 instead of itemizing, since our property tax is now capped at $10K.
We have a 4.125%, $340K mortgage on a $500K home with 26 years left. For at least the next several years, it looks like we will have at least $20K annually to either put towards mortgage principal or invest in aftertax index funds.
I ran an excel analysis over this 26 year period assuming an aftertax investment growth rate of 6%. Here are the results I achieved for both scenarios....
Scenario 1: First 10 years all money goes towards principal, house gets paid off, and annual investments of $40K kick in ($20K + an additional 20K that previously went to the mortgage), starting in year 11 and lasting through year 26. On three separate occasions in the first 10 years, I assumed we would need to kick in an extra 10K, so an extra $30K was added. When I consider 16 years of after tax investments, the total sum comes to $1.027M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $0.969M
Scenario 2: First 10 years we contribute $20K annually plus the extra $30K described in scenario 1. From year 11  year 26, we continue investing 20K annually as we continue to pay our mortgage. The total sum comes to $1.282M. When considering 15% cap gains tax on the growth, this brings the realized sum down to $1.166.
So it does indeed seem that even with paying the bank on a longer mortgage, I would in theory come out well ahead by keeping the mortgage. I also like that this money would be more accessible should it be needed. Anyway, any thoughts are welcome, but I do think this decision seems to be an individual preference call.
I am typically not one to push people to pay off mortgage but if you are at over 4% with no tax deduction it is worth considering IF you fully fund all retirement account opportunities and IF you otherwise have ample liquidity.
Here are some other alternatives to consider:
1. Can you refinance to 15 years to something in the 3% range with low upfront fees?
2. Split the difference, You could choose to put half down on your mortgage and the other half in an after tax portfolio.
3. If you choose to payoff mortgage, increase your asset allocation more towards stocks in a retirement accounts. Paying off your mortgage is similar to investing in a risk free bond.
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
Of course if your assumption says you will return 6% in stocks it will outperform the mortgage. Based on this wouldn't you be stupid to not go out and get a HELOC and invest even more?
 whodidntante
 Posts: 4194
 Joined: Thu Jan 21, 2016 11:11 pm
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
HELOCs can get above 6% pretty quickly. One regular poster here did a cash out refi to invest.
 whodidntante
 Posts: 4194
 Joined: Thu Jan 21, 2016 11:11 pm
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
Assuming the rate is reasonable (and yours is) I think it's wise to have a large amount of liquidity before considering prepaying a mortgage. And if one invests in a taxable account, I think it's wise to buy equity index ETFs for that. Once you build up a large amount of liquidity, then you can consider if it makes sense to prepay your mortgage (probably not).
Re: Pay Mortgage Vs AfterTax Investments (Yes, again)  New Standard Deduction
See Paying down loans versus investing on the wiki.
However, this isn't a fair comparison; you can earn 6% on risky investments, or 4.125% on riskfree investments. You could just as well increase your risk and expected returns by selling some of your current lowrisk investments to buy risky investments, and that would be a better deal. That is why I suggest comparing the mortgage rate to bond returns.
If you are considering paying extra on your mortgage, I would suggest refinancing to 15 years, so that you will pay less in interest.
But even then, if you refinance to 15 years, paying extra on a 15year mortgage is a 3.5% riskfree investment with a duration of 15 years (or less if you sell the house before the 15 years are up). And if that is taxfree (because you can't deduct the interest), then it is a good deal.
The reason I don't do the same is that the numbers don't work out for me. I pay 2.625% on my 11year mortgage, and that is only 2.00% after federal tax because I can still deduct the interest. I can earn more than 2% on lowrisk bonds, so buying bonds is a better deal than paying down my mortgage. (I don't actually buy bonds in my taxable account, but I do buy them; I hold bonds in my employer plan, and use spare cash to buy stock in my taxable account.)
This is correct, unless you donate to charity. Therefore, paying down your mortgage is a riskfree 4.125% return.PlayingLife wrote: ↑Thu Mar 01, 2018 1:50 pm*Our historical tax deductions are pretty much limited to property tax ($14K) and mortgage interest (<$14K). I'm assuming we'll claim the new standard $24K deduction in 2018 instead of itemizing, since our property tax is now capped at $10K.
You don't need to run this analysis. If your investments grow by 6%, and you get a 4.125% return on paying down the mortgage, then investing comes out ahead.I ran an excel analysis over this 26 year period assuming an aftertax investment growth rate of 6%.
However, this isn't a fair comparison; you can earn 6% on risky investments, or 4.125% on riskfree investments. You could just as well increase your risk and expected returns by selling some of your current lowrisk investments to buy risky investments, and that would be a better deal. That is why I suggest comparing the mortgage rate to bond returns.
If you are considering paying extra on your mortgage, I would suggest refinancing to 15 years, so that you will pay less in interest.
But even then, if you refinance to 15 years, paying extra on a 15year mortgage is a 3.5% riskfree investment with a duration of 15 years (or less if you sell the house before the 15 years are up). And if that is taxfree (because you can't deduct the interest), then it is a good deal.
The reason I don't do the same is that the numbers don't work out for me. I pay 2.625% on my 11year mortgage, and that is only 2.00% after federal tax because I can still deduct the interest. I can earn more than 2% on lowrisk bonds, so buying bonds is a better deal than paying down my mortgage. (I don't actually buy bonds in my taxable account, but I do buy them; I hold bonds in my employer plan, and use spare cash to buy stock in my taxable account.)