When mortgage rates are high, why invest in stock market?

[jastevenson]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

[willthrill81]

U.S. stocks have indeed averaged 7% after inflation over the long-term, 10% before inflation. So if one was just relying on the historic numbers, a 7% mortgage interest rate would be lower than the stock market's 10%. However, as history as shown us, your mileage may vary. Since 2000, U.S. stocks have returned 3.5% after inflation, so you would have been better off paying down that mortgage over that entire time period. But since 2002, stocks have returned 5.69% after inflation, so you would have been better off investing since then (apart from tax implications).

The other aspect of this, though, is that paying down a mortgage provides you a guaranteed nominal (i.e. before inflation) return on your money equivalent to your mortgage interest rate. There's a lot to be said for that.

Our mortgage interest rate is just 3.375%, and we've chosen to pay that off very early, mainly because we're debt averse. We know that this isn't likely to be mathematically optimal, but that doesn't matter to us. And there aren't many places where you can get a guaranteed 3.375% nominal return on your money today.

[mortfree]

If all of your savings go to extra on the mortgage you won’t have any liquid money.

[HEDGEFUNDIE]

Mortgage rates closely track long term Treasury rates, which themselves are considered “risk-free” rates.

If the risk free rate was 7% you would actually expect equity returns to be 12-14%

[wootwoot]

Take a look at the stock market over the mid-late 90s. People were used to higher than 7% nominal returns and expected growth to continue on that path.

[jimb_fromATL]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

That does work for after-tax money in taxable accounts. And even at today's rates there are currently no other investments that can give you a guaranteed rate as good as your equivalent return for paying down the mortgage.

But there are some more things to think about first:

Mortgages (and other debts) are compound interest -- in reverse. The borrower's debt is the lender's investment in an annuity that has a guaranteed rate of return with a guaranteed minimum monthly payout. So paying extra on your mortgage gives you the same return on your investment for your extra payments on the principal.

Your equivalent rate of return is actually slightly better than the mortgage rate because you would be paying tax on earnings in an investment or savings account, but there is no tax on money that you decide to keep for yourself by not paying it out as interest to your lender.

Time is an exponential factor in earning compound interest. You'll be earning compound interest for the rest of your life in your 401(k) but even mortgages are much shorter by comparison -- with any luck at all. There are also yearly limits for 401(k)s that can prevent you from being able to catch up by reinvesting the freed-up payments when you pay off a debt faster.

So for most folks who are paying any significant income taxes, it makes more financial sense to invest as much as possible in tax-advantaged retirement plans as soon as possible, rather than paying down manageable debts too fast.

Your 401(k) or other tax-deferred plan also lets you defer taxes in your highest federal bracket (and usually state tax too). If you reduce your 401(k) contributions, then the money that will be going to pay taxes will not be buying necessities, paying bills, paying down debt, or earning compound interest for your benefit for the rest of your life either.

To give you an example of why you should contribute the max to your tax-deferred plan(s) first, consider this:

• Let's suppose for simplicity that you have a 30 year mortgage which will be paid off at the same time you retire.
  
  If you stopped contributing $18,500 per year ($1541.67 per month) to a 401(K) and if your top tax brackets were 22% federal and 6.% state for a total of 28.% then you would pay $431.67 per month more in taxes, leaving $1110.00 to pay on the debt.
  
  That $431.67 is money that won't pay bills, buy necessities, earn compound interest for the rest of your life, or pay down debt either.
  
  A mortgage balance of $200,000 at 7.% with 360 months remaining has a payment of $1330.60 per month for P&I. The total interest will be $279,018.
  
  Not contributing to the 401(k) and and adding the $1,110 per month remaining after tax to the loan payment will pay off the debt in 111.8 months with $72,801 in interest. So you save $206,217 in interest and 248.2 months time on the debt.
  
  That sounds pretty good at first, but notice that during that 111.8 months you've paid an extra $48,250 in taxes that you could have invested for yourself in order to save that $206,217 in interest.
  
  If you did not delay your contributions, the investment of $1541.67 per month earning 7% would grow to $1,880,789 by retirement time 30. years from now.
  
  Just a 111.8 months delay before starting contributions while paying down the debt will cause it to grow to only $855,393 in the remaining 248.2 months. That's a loss of $1,025,396 at retirement in exchange for saving $206,217 in interest on the debt.
  
  I don't know anyone who ever did it -- and we didn't after paying off our mortgage(s) either -- but if you had the sticktoitivity to actually do it, you could invest the freed up payments after the mortgage is paid off.
  
  You will already have resumed the max to the 401(k), so you won't get to defer any taxes on the re-invested funds. but if you were to re-invest the 248.2 freed-up payments of $1331 in an after-tax account with no delay starting after month 111.8, and if you could clear 7% after paying taxes on dividends every year, it would grow to $738,285 by the end of the original 360 months.
  
  Added to the $855,393 you would have from resuming the $1542 contributions to the 401(k), your total at retirement would be $1,593,678.
  
  That is still a loss of $287,111 at retirement for exactly the same money out of pocket.

But those losses are only the tip of the iceberg.

• If you were to earn a conservative 4% after retirement, that $1,025,396 that you won't have at retirement if you don't reinvest the payments could have paid you an extra $3417.99 per month without even touching the principal. ( At 3% inflation for 30 years, that would be equivalent to an extra $1408/mo. in income today.)
  
  So if you lived another 30 years, you would have lost the $1,025,396 that you won't have at retirement, plus the $1,230,475 of interest it won't earn after retirement, for a total loss of $2,255,871 in the long term in exchange for saving $206,217 in interest on the short-term debt.
  
  That's a cost of $11 out of your future retirement income for every dollar you saved on the debt, or $9,088 for every month you cut from the debt.
  
  Even if you religiously reinvested the freed-up payments, then at 4% after retirement, the extra $287,111 that you won't have could have paid you an extra $957 in interest every month without touching the principal.
  
  If you lived another 30 years that would be another $344,533 for a total lifetime loss of $631,644 in exchange for saving $206,217 on the short-term debt. That's still losing $3 out of your future retirement for ever dollar of interest saved on the debt.

Here are some links to several threads where my posts show examples of how delaying your tax-advantaged retirement investing and paying taxes prematurely in order to pay down manageable debts too fast can --depending on your age, income and tax brackets -- literally cost anywhere from tens to hundreds of thousands to sometimes millions of dollars out of your future retirement income in exchange for saving only a tiny fraction as much interest on the relatively short term debts.

• viewtopic.php?f=2&t=136151&p=2011928#p2011928 Student Loans and Retirement help
  viewtopic.php?t=136385 Paying student loans vs Losing compounding interest
  viewtopic.php?f=2&t=128788 Swamped In Debt - Thoughts?
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  viewtopic.php?f=2&t=129906 Mortgage PMI or Student Loan?
  viewtopic.php?f=1&t=180529 Pay down mortgage or stuff retirement accounts?
  viewtopic.php?f=1&t=178566 Mortgage or 401k

jimb

[Goal33]

Cuz liquidity

[28fe6]

U.S. stocks have indeed averaged 7% after inflation over the long-term, 10% before inflation. So if one was just relying on the historic numbers, a 7% mortgage interest rate would be lower than the stock market's 10%. However, as history as shown us, your mileage may vary. Since 2000, U.S. stocks have returned 3.5% after inflation, so you would have been better off paying down that mortgage over that entire time period. But since 2002, stocks have returned 5.69% after inflation, so you would have been better off investing since then (apart from tax implications).

The other aspect of this, though, is that paying down a mortgage provides you a guaranteed nominal (i.e. before inflation) return on your money equivalent to your mortgage interest rate. There's a lot to be said for that.

Our mortgage interest rate is just 3.375%, and we've chosen to pay that off very early, mainly because we're debt averse. We know that this isn't likely to be mathematically optimal, but that doesn't matter to us. And there aren't many places where you can get a guaranteed 3.375% nominal return on your money today.

I agree with this logic when comparing taxable or Roth investment, but it breaks down for me when comparing tax deferred investment. I stopped paying extra on my mortgage when I realized I was giving up deferral of 22% tax in order to do it. Even 12% dominates any mortgage rate. Do max your tax deferred space?

[JoeRetire]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

You seem to be assuming that folks couldn't do both.

At least for me, I was getting more than 7% return on my stock market investments. I'm not sure where your numbers came from. Seems like you picked a particular point in time for mortgage rates, and a wide stretch of time for market returns? That makes no sense.

[willthrill81]

U.S. stocks have indeed averaged 7% after inflation over the long-term, 10% before inflation. So if one was just relying on the historic numbers, a 7% mortgage interest rate would be lower than the stock market's 10%. However, as history as shown us, your mileage may vary. Since 2000, U.S. stocks have returned 3.5% after inflation, so you would have been better off paying down that mortgage over that entire time period. But since 2002, stocks have returned 5.69% after inflation, so you would have been better off investing since then (apart from tax implications).

The other aspect of this, though, is that paying down a mortgage provides you a guaranteed nominal (i.e. before inflation) return on your money equivalent to your mortgage interest rate. There's a lot to be said for that.

Our mortgage interest rate is just 3.375%, and we've chosen to pay that off very early, mainly because we're debt averse. We know that this isn't likely to be mathematically optimal, but that doesn't matter to us. And there aren't many places where you can get a guaranteed 3.375% nominal return on your money today.

I agree with this logic when comparing taxable or Roth investment, but it breaks down for me when comparing tax deferred investment. I stopped paying extra on my mortgage when I realized I was giving up deferral of 22% tax in order to do it. Even 12% dominates any mortgage rate. Do max your tax deferred space?

Keep in mind that some amount of taxes are usually paid on withdrawals from tax-deferred accounts, so it's not a free lunch there either.

We aren't yet maxing out all of our tax-advantaged space, and even once our mortgage is paid off, I doubt that we'll be able to do so then either even with a 50% savings rate. I've crunched the numbers and know that what we're doing is optimal in the sense of maximizing our after-tax capital in the long-run, but we're both debt averse, especially my DW. And as the saying goes, "happy wife, happy life."

[willthrill81]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

You seem to be assuming that folks couldn't do both.

At least for me, I was getting more than 7% return on my stock market investments. I'm not sure where your numbers came from. Seems like you picked a particular point in time for mortgage rates, and a wide stretch of time for market returns? That makes no sense.

It's easy for people to think in binary terms, but the reality is often that diversification is 'optimal', especially when faced with uncertainty. Even though we're aggressively paying down our mortgage, for instance, we're still saving 20% of our gross household income while we do so. That savings rate will go up to 50% once the mortgage is paid off.

[H-Town]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Taking on a big mortgage is a big speed bump on the road to accumulate wealth. When mortgage rates are high, the right question to ask is why take on a mortgage to begin with.

[epilnk]

The short answer is liquidity has a disproportionate value to some people at certain stages of their lives. A young family employed in a volatile industry may choose to keep assets more liquid.

The longer answer is long term trends require a pretty long horizon. Those of us who are disillusioned by the crystal ball method of asset allocation yet remain concerned about short term trends may prefer to hedge our bets. Especially when the predicted outcomes are similar. In other words, we did both.

The historic answer is that the 2000s was the lost decade. Investments made in 2000 most likely did not return anywhere near 7% annualized by 2010, given that there were two major stock market recessions in there. In hindsight the people who paid down their mortgage were the winners; the people who both paid down their mortgage while serially refinancing as interest rates dropped were the big winners.

[averagedude]

I bought my house in 1999 with an interest rate slightly above 7%. I saved roughly 20% of my income to tax deferred accounts and also payed more on the mortage and payed it off in 2010. I believe it is best to buy a house that you can pay off in 15 years and also be able to save 10% of your income for retirement. If you cant do this, then you are purchasing too much house. I believe it is still wise to invest because you can get free money from your employer if they offer a match on a 401k. It also develops the habit of saving that is required to build wealth.

[CurlyDave]

U.S. stocks have indeed averaged 7% after inflation over the long-term, 10% before inflation. So if one was just relying on the historic numbers, a 7% mortgage interest rate would be lower than the stock market's 10%. However, as history as shown us, your mileage may vary. Since 2000, U.S. stocks have returned 3.5% after inflation, so you would have been better off paying down that mortgage over that entire time period. But since 2002, stocks have returned 5.69% after inflation, so you would have been better off investing since then (apart from tax implications).

The other aspect of this, though, is that paying down a mortgage provides you a guaranteed nominal (i.e. before inflation) return on your money equivalent to your mortgage interest rate. There's a lot to be said for that.

Our mortgage interest rate is just 3.375%, and we've chosen to pay that off very early, mainly because we're debt averse. We know that this isn't likely to be mathematically optimal, but that doesn't matter to us. And there aren't many places where you can get a guaranteed 3.375% nominal return on your money today.

The mortgage payments are in nominal (not real) dollars.

So a stock market return of over 7% nominal would be advantageous.

[andypanda]

As already mentioned, do both. If you can't do both, maybe you're looking at too much house.

I bought my home in January of 1980. I put 26% down on a 70-year-old fixer upper and got a 30-year conventional mortgage at 12.75%. It was a deal, the rates kept going up. Iirc they went to 16 or 18%.

Meanwhile, I continued to live like a starving grad student for a few years and continued to buy stock. Eventually a combination of salary increases and refinancing to 9.25% for 15 years and then to 7% for 15 years improved my budget and allowed me to invest even more. I paid it off in 1997 and now the taxes are killing me because I now live in a very, very popular historic district with stupidly high assessments - and higher sales prices - on even the smallest properties.

[basspond]

We had a mortgage in that time frame, but our initial loan was over 8%, in the late 80's it was over 10%. The best way to save/invest interest expense is to reduce your mortgage term. Also, there are hidden expenses with mortgages and owning a house that is not factored in the mortgage rate.

[Bacchus01]

We have bought houses in 1998, 2004, 2006, 2010, 2013, and 2016. We have refinanced in 2008, 2012. and 2017.

Other than the 1998 buy at 6.75% as our first home with just 5% down, we have never had a rate over 4% and most were under 3%.

I’m not seeing this 7% argument for mortgages in any lasting reality to date.

[wolf359]

We have bought houses in 1998, 2004, 2006, 2010, 2013, and 2016. We have refinanced in 2008, 2012. and 2017.

Other than the 1998 buy at 6.75% as our first home with just 5% down, we have never had a rate over 4% and most were under 3%.

I’m not seeing this 7% argument for mortgages in any lasting reality to date.

OP is posting a hypothetical, because rates have been at all-time historic lows for over a decade. Your experience is just repeating that.

Just because rates were dropped by the financial crisis doesn't mean that they will last that way forever. Mortgages really have been higher in the not-to-distant past. See Freddie Mac for historic rates of 30 year fixed mortgages since 1971. http://www.freddiemac.com/pmms/pmms30.html

[AlohaJoe]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Isn't the real question "why would someone take out a mortgage when rates are that high when they could instead be investing in the stock market"?

[jimb_fromATL]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Isn't the real question "why would someone take out a mortgage when rates are that high when they could instead be investing in the stock market"?

Because they cannot live in the stock market.

jimb

[Bacchus01]

We have bought houses in 1998, 2004, 2006, 2010, 2013, and 2016. We have refinanced in 2008, 2012. and 2017.

Other than the 1998 buy at 6.75% as our first home with just 5% down, we have never had a rate over 4% and most were under 3%.

I’m not seeing this 7% argument for mortgages in any lasting reality to date.

OP is posting a hypothetical, because rates have been at all-time historic lows for over a decade. Your experience is just repeating that.

Just because rates were dropped by the financial crisis doesn't mean that they will last that way forever. Mortgages really have been higher in the not-to-distant past. See Freddie Mac for historic rates of 30 year fixed mortgages since 1971. http://www.freddiemac.com/pmms/pmms30.html

I gave my experience over the timeframe that the OP postulated. Your are talking about a timeframe that the OP did not. You are extending it well beyond the timeframe the OP discussed. The OP specifically asked about the early 2000s. You are looking at 1971. I'm not sure how your data is at all relevant to what the OP asked.

I gave the actual account. I don't know who was actually paying 7% in 2002 as the OP discusses. I certainly wasn't, and I bought or refinanced NINE times over a 20 year period and only ONCE was I even close to 7%. The rate I got in 2004, the closest to the OP timeframe, was 4%. I would suspect that it is relevant to the discussion given the timeframe the OP suggested.

The question had nothing to do with the 1970s or 1980s, and wasn't at all about the future and possible volatility.

[willthrill81]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Isn't the real question "why would someone take out a mortgage when rates are that high when they could instead be investing in the stock market"?

Because they cannot live in the stock market.

jimb

Bingo.

It's not a question of mortgage vs. stocks. It's a question of mortgage vs. renting, unless you have some arrangement where you can live for free.

[rgs92]

Average returns are deceiving. I bet if you look at things, in any year you are bound to be way off the long term average.
Murphy's law will kick in when you move a large amount of money from the market to your mortgage and you'll miss a 30-40% gain and kick yourself.
There is all this evidence about missing the 10 best days in the market or the best year or the like.

[JBTX]

Answers to OP:

1. Typically when interest rates are high, that is a good time to invest in stocks because they are likely depressed. 1999/2000 was clearly an exception.

2. If when rates go down, you can always refinance. We refinanced several times since 1998.

[Dottie57]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Because you can’t spend your house.

[willthrill81]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Because you can’t spend your house.

Well...you actually can. That's what reverse mortgages do. I'm not advocating them, but that's their premise.

[Dottie57]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Because you can’t spend your house.

Well...you actually can. That's what reverse mortgages do. I'm not advocating them, but that's their premise.

I would rather sell it for LTC monies and not retirement in general. I don’t think reverse mortgages are a great option. I would rather have multiple sources for generating cash. Stock and bond funds are more liquid.

Selling a house generates cash, but what to do about housing after selling? Renting would be more expensive for me.

[andypanda]

"Isn't the real question "why would someone take out a mortgage when rates are that high when they could instead be investing in the stock market"?"

In my limited experience over the past 40 years or so in a very high demand inner city neighborhood, the answer is: Because when the rates drop the selling prices jump. Buy now, refinance later. The best of both worlds.

I don't know how it works out in the burbs.

[Bastiat]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Taking on a big mortgage is a big speed bump on the road to accumulate wealth. When mortgage rates are high, the right question to ask is why take on a mortgage to begin with.

My net worth would likely be less than half of what it is today had I not bought my first house/investment property with the largest VA mortgage the bank would give me.

[grabiner]

I agree with this logic when comparing taxable or Roth investment, but it breaks down for me when comparing tax deferred investment. I stopped paying extra on my mortgage when I realized I was giving up deferral of 22% tax in order to do it. Even 12% dominates any mortgage rate. Do max your tax deferred space?

The domination calculation is mostly incorrect, because the tax deduction is not free; it is in return for a later tax benefit. If your marginal tax rate is 22% now, you could contribute $10,000 less to your 401(k), or $7800 less to your Roth account, to pay $7800 against your mortgage. Then, when you retire, if your investment doubles in value, you will have $20,000 less in your 401(k), or $15,600 less in your Roth account. If you are still in a 22% bracket, you will lose $15,600 either way, and can compare that to the benefit you would have had from making a mortgage prepayment. (For example, paying down a 4% non-deductible mortgage which will be paid off in 18 years gives you a risk-free doubling of the value.)

The reason I say "mostly incorrect" is that there is a net tax benefit if you retire in a lower tax bracket. If you contribute $10,000 to a traditional 401(k) in a 22% bracket, that cost you $7800 out of pocket. If you retire in a 15% bracket, you get back $8500 plus the tax-free growth. This adds 9% to the return on your investments (but still not 22%). Therefore, if you expect to retire at a lower marginal tax rate, it is usually better to max out your 401(k) before paying down your mortgage.

[randomguy]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Isn't the real question "why would someone take out a mortgage when rates are that high when they could instead be investing in the stock market"?

Because they cannot live in the stock market.

jimb

Bingo.

It's not a question of mortgage vs. stocks. It's a question of mortgage vs. renting, unless you have some arrangement where you can live for free.

And the other thing is that YOLO and interest rate trends last a long time. Mortgage rates were above 7% from basically 1970 to 2002. So the newly married 25 year old would have had to wait til they were 57 to buy at "low" mortgage rates. Thats a lot of living. Your house is a combo investment/lifestyle choice and most people don't aim at maximizing the investment side

[28fe6]

I agree with this logic when comparing taxable or Roth investment, but it breaks down for me when comparing tax deferred investment. I stopped paying extra on my mortgage when I realized I was giving up deferral of 22% tax in order to do it. Even 12% dominates any mortgage rate. Do max your tax deferred space?

The domination calculation is mostly incorrect, because the tax deduction is not free; it is in return for a later tax benefit. If your marginal tax rate is 22% now, you could contribute $10,000 less to your 401(k), or $7800 less to your Roth account, to pay $7800 against your mortgage. Then, when you retire, if your investment doubles in value, you will have $20,000 less in your 401(k), or $15,600 less in your Roth account. If you are still in a 22% bracket, you will lose $15,600 either way, and can compare that to the benefit you would have had from making a mortgage prepayment. (For example, paying down a 4% non-deductible mortgage which will be paid off in 18 years gives you a risk-free doubling of the value.)

The reason I say "mostly incorrect" is that there is a net tax benefit if you retire in a lower tax bracket. If you contribute $10,000 to a traditional 401(k) in a 22% bracket, that cost you $7800 out of pocket. If you retire in a 15% bracket, you get back $8500 plus the tax-free growth. This adds 9% to the return on your investments (but still not 22%). Therefore, if you expect to retire at a lower marginal tax rate, it is usually better to max out your 401(k) before paying down your mortgage.

I expect to use my tax-deferred money first in retirement, and then use Roth funds in higher tax brackets. I expect most of my 401k distributions to be taxed at zero or at most 12/15% or something. Even for the portion taxed at 12%, the difference is 10 percent between 22 percent deferred now and say 12 percent in retirement, and 10 percent is a lot more than the mortgage. Don't forget the mortgage is paid in nominal dollars so if inflation kicks up, that's even more win. Oh, and I can refinance if rates drop.

If you have maxed out all tax deferred space, have money left over, and are trying to decide whether to make even more stock/bond taxable investments or pay down debt, then it would make sense to me to pay down mortgage instead. As for me, I will not make any taxable investments until my mortgage is paid off because 3.5% guaranteed, with a promise of increasing my cash flow once paid off, is good enough for me. But I struggle to max out 401k, HSA, tIRA and still have anything left over either to pay extra on the mortgage or to make taxable investments, so the question is moot for me. But I will not forgo deferring 22 percent tax in order to pay down a 3.5 percent nominal mortgage.

[Valuethinker]

As already mentioned, do both. If you can't do both, maybe you're looking at too much house.

I bought my home in January of 1980. I put 26% down on a 70-year-old fixer upper and got a 30-year conventional mortgage at 12.75%. It was a deal, the rates kept going up. Iirc they went to 16 or 18%.

Meanwhile, I continued to live like a starving grad student for a few years and continued to buy stock. Eventually a combination of salary increases and refinancing to 9.25% for 15 years and then to 7% for 15 years improved my budget and allowed me to invest even more. I paid it off in 1997 and now the taxes are killing me because I now live in a very, very popular historic district with stupidly high assessments - and higher sales prices - on even the smallest properties.

Underlining that houses are, generally, a poor long term financial investment - because of the high cost of carrying the investment (both physical repairs & outgoings like property taxes).

It's also the case that if you live in certain (generally coastal) cities that your house has been the best investment ever, since about the early 1980s. London, New York, San Francisco, LA, perhaps Portland & Seattle. Thus proving that in housing, it's all about location.

[Valuethinker]

I'm probably missing something blindingly obvious, but I was reading earlier today that mortgage rates in the early 2000s were over 7%.

Given that average stock market return is about 7% over time, why was anyone (with a mortgage) investing in the stock market in, say, 2002? Because wouldn't paying down the mortgage result in a guaranteed 7% return?

Stock market returns in the 1980s and 1990s were c. 10% (nominal) per annum (wide variation, but I think overall the average was something like that).

So, borrow at 7%, invest for 10%. Money machine.

However stock markets peaked in 2000 and then had a torrid 12 years or so (US markets; other countries even further behind). So the "bet" to borrow on the house and invest, did not work well.

A related issue is that one generally has annual tax advantaged accounts limits to contributions. Lose them, lose them forever.

Thus, the standard advice (here, and elsewhere) is, I think, to make sure you use those before you pay down your mortgage.

Conversely with high interest personal loans like student debt, it's usually better to pay those down first. A certain return of 6-7%, say, beats any potential stock market return.

[andypanda]

"Underlining that houses are, generally, a poor long term financial investment - because of the high cost of carrying the investment (both physical repairs & outgoings like property taxes).

It's also the case that if you live in certain (generally coastal) cities that your house has been the best investment ever, since about the early 1980s. London, New York, San Francisco, LA, perhaps Portland & Seattle. Thus proving that in housing, it's all about location."

Yes, and it also applies to certain neighborhoods. Look up Richmond Virginia's Fan District and Museum District. Here... https://en.wikipedia.org/wiki/Fan_district

The Museum District starts at the western edge of the Fan District. The Fan was built from 1899 to 1920, and the Museum District from 1915 to 1925.

I didn't mind taking a 30-year mortgage at 12.75% in 1980 because I only paid $41,000 for the house and borrowed $32k. Of the dozen or so little 2-story brick houses on my block, all 1350 sq.ft. freestanding town homes with full basements and 3 porches, the most recently and elaborately renovated one sold for $499,000 last year. Luckily, city taxes are only $1.20 per hundred. I mow the backyard with a small electric mower and one 25-foot extension cord.

[Valuethinker]

"Underlining that houses are, generally, a poor long term financial investment - because of the high cost of carrying the investment (both physical repairs & outgoings like property taxes).

It's also the case that if you live in certain (generally coastal) cities that your house has been the best investment ever, since about the early 1980s. London, New York, San Francisco, LA, perhaps Portland & Seattle. Thus proving that in housing, it's all about location."

Yes, and it also applies to certain neighborhoods. Look up Richmond Virginia's Fan District and Museum District. Here... https://en.wikipedia.org/wiki/Fan_district

The Museum District starts at the western edge of the Fan District. The Fan was built from 1899 to 1920, and the Museum District from 1915 to 1925.

I didn't mind taking a 30-year mortgage at 12.75% in 1980 because I only paid $41,000 for the house and borrowed $32k. Of the dozen or so little 2-story brick houses on my block, all 1350 sq.ft. freestanding town homes with full basements and 3 porches, the most recently and elaborately renovated one sold for $499,000 last year. Luckily, city taxes are only $1.20 per hundred. I mow the backyard with a small electric mower and one 25-foot extension cord.

Neat.

The below district in Toronto was, in 1970, a hippy-ish area of dilapidated Victorian townhouses, attached and detached. Americans who came to Canada (partly due to the Vietnam War, partly young academics) bought up the houses and did them out. It now backs on to what Fortune Magazine said in 2008 was the 7th most expensive shopping district in the world "The Mink Mile".

I would bet you could have bought a house for $100k in Yorkville in 1970 that would now be over $3m. Unfortunately, the zoning controls are not tight enough, and houses are going down and 30 storey condos are going up - the retail small unit flavour of the area is being destroyed.

https://en.wikipedia.org/wiki/Yorkville,_Toronto