Pre-paying mortgage only in early years

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30investor
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Pre-paying mortgage only in early years

Post by 30investor » Sun Dec 16, 2018 9:27 pm

I have searched for this topic and haven't found it some I'm probably missing some obvious reason why it doesn't make sense. But given the amortization schedule of a mortgage would there be an argument to pre-pay heavily for the first 50-75% of the life of the mortgage when 50-60% of your payments are going to interest and then stopping for the later years when the majority of your payments are principal anyway and presumably inflation has devalued the mortgage amount anyway? I realize doing this delays the cash flow boost of having the mortgage paid off. It also knocks out the interest early which lessens the tax deduction but the deduction isn't a dollar for dollar tradeoff anyway. What am I missing or not considering?

This is a general question so I don't know that the specific stats matter but I have a 3.75% 30 year fixed mortgage that I owe about $255K on. I'm about 3.5 years in but I've prepaid from time to time already so I'd need to rerun the numbers to find my current payoff date.

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whodidntante
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Re: Pre-paying mortgage only in early years

Post by whodidntante » Sun Dec 16, 2018 9:29 pm

You're basically concluding that a dollar today is worth more than a dollar 30 years from now.

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Nate79
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Re: Pre-paying mortgage only in early years

Post by Nate79 » Sun Dec 16, 2018 9:55 pm

Unfortunately people get really confused with amortization schedules but they are quite simple. The amount of interest you pay each month is simply the interest rate (divided by 12 to make it a monthly rate) * the outstanding principle of the loan. What this means is that no matter at the beginning or the end of a loan an extra dollar paid against the principle gets a return of the interest rate of the loan.

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Epsilon Delta
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Re: Pre-paying mortgage only in early years

Post by Epsilon Delta » Sun Dec 16, 2018 9:58 pm

And since short term interest rates are usually lower than long term rates you should be slightly more willing to pre-pay of a mortgage in the later years.

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Re: Pre-paying mortgage only in early years

Post by stan1 » Sun Dec 16, 2018 10:03 pm

I would save for retirement first (max out 401Ks and IRAs), build up a low six figure taxable account, and then only after that consider paying down a mortgage early with one or two extra payments per year. Build your wealth. Housing is an expense since we have to live somewhere and I don't mind treating a mortgage as an expense rather than a liability. Most people's income grows in their 30s and 40s and disposable incomes grow after kids are out of college. Pay off the mortgage then.

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Re: Pre-paying mortgage only in early years

Post by grabiner » Sun Dec 16, 2018 10:16 pm

The benefit doesn't depend on how much of the current payment is principal or interest; it depends on what happens to future payments. If you have a 3.75% mortgage, and you make an extra $10,000 payment, your balance next year will be $10,375 less, with $375 in saved interest (and $375 more taxable income if that interest was deductible).

The effect is the same as if you had bought a bond yielding 3.75%, with duration equal to the mortgage. If you have 20 years left on the mortgage, your $10,000 payment will give you $20,882 more in 20 years, by eliminated payments then. If you bought a 20-year zero-coupon bond, you would also have $20,882 in 20 years.

At your mortgage rate and current bond yields, I wouldn't recommend making extra payments unless you are maxing out your retirement accounts, are not deducting the mortgage interest, and are likely to sell the house in ten years or less. If you aren't maxing out your retirement accounts, you could earn 4.18% on Vanguard Long-Term Bond ETF. If you are maxing out, you could earn 3.14% on Vanguard Long-Term Tax-Exempt Admiral Shares, but that fund has only a 7-year duration, and thus less interest-rate risk. (The interest-rate risk on the mortgage prepayment is that you might find out that you have 15 years left on your 3.75% mortgage and the ability to earn 5% on bonds, and your bank can't do anything about it.)
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Epsilon Delta
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Re: Pre-paying mortgage only in early years

Post by Epsilon Delta » Sun Dec 16, 2018 10:18 pm

Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".

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Re: Pre-paying mortgage only in early years

Post by phantom0308 » Sun Dec 16, 2018 10:36 pm

You’re not considering the opportunity cost of paying off the mortgage early. Paying off your mortgage early is equivalent to making a guaranteed return equal to the interest of the loan minus any tax deductions lost. So yes it pays off to make that investment earlier because you will have the money not paid (equivalent to the return) earlier.
An alternative could be to keep the money in your bank account making 1%. Then use it years later to pay off the mortgage. This is a worse return but safer in some ways because you have more liquidity.
Another alternative would be to invest it in the stock market. The expected return is higher, but risk is higher. Making that investment earlier pays off more than paying the mortgage earlier.
Another alternative would be to spend the money. The financial return would probably be worse, but you could get returns in other ways such as education, happiness, etc.

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Re: Pre-paying mortgage only in early years

Post by TheHouse7 » Sun Dec 16, 2018 10:52 pm

Epsilon Delta wrote:
Sun Dec 16, 2018 10:18 pm
Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".
+1
"PSX will always go up 20%, why invest in anything else?!" -Father-in-law early retired.

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Re: Pre-paying mortgage only in early years

Post by TarHeel2002 » Mon Dec 17, 2018 9:26 am

I am wrestling with this question right now too. I am 6 years into a 30 year fixed rate mortgage 3.125%. Total balance due $151,750 and payments of $750/month. With the standard deduction rising my mortgage interest is no longer deductible. Beginning in January I am looking at:

A. Investing $1500-$2000/month into a taxable account (VTSAX)
B. Paying down the mortgage $1500-2000 month faster

I keep going back and forth on it. I am currently maxing out all tax advantaged retirement options available to me (401k, Roth, HSA). Some would say do a mix of both but I want to pick one an run with it. It's difficult because both sides appeal to me - paying off the mortgage early and watching the balance shrink every month. I also like the thought of watching a taxable account growing and increased liquidity beyond my emergency fund.

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Re: Pre-paying mortgage only in early years

Post by alfaspider » Mon Dec 17, 2018 9:35 am

Epsilon Delta wrote:
Sun Dec 16, 2018 10:18 pm
Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".
I don't see how prepaying a mortgage is building wealth. You are simply transferring one investment (whatever investment the money you use to prepay is coming from), to another (home equity, and the imputed bond you are buying at the rate of the mortgage). If you are a standard BH 2/3 funder, it's effectively equivalent to re balancing your portfolio in favor of debt over equity.

It may or may not be the right decision, but the immediate impact on your net worth is zero.

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Re: Pre-paying mortgage only in early years

Post by Jags4186 » Mon Dec 17, 2018 9:37 am

TarHeel2002 wrote:
Mon Dec 17, 2018 9:26 am
I am wrestling with this question right now too. I am 6 years into a 30 year fixed rate mortgage 3.125%. Total balance due $151,750 and payments of $750/month. With the standard deduction rising my mortgage interest is no longer deductible. Beginning in January I am looking at:

A. Investing $1500-$2000/month into a taxable account (VTSAX)
B. Paying down the mortgage $1500-2000 month faster

I keep going back and forth on it. I am currently maxing out all tax advantaged retirement options available to me (401k, Roth, HSA). Some would say do a mix of both but I want to pick one an run with it. It's difficult because both sides appeal to me - paying off the mortgage early and watching the balance shrink every month. I also like the thought of watching a taxable account growing and increased liquidity beyond my emergency fund.
At 3.125% I would hold onto it as long as possible. I mean I know we can be conservative on this website, but do you really believe that over the next 24 years your investments will return less than 3.125%?

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Re: Pre-paying mortgage only in early years

Post by chevca » Mon Dec 17, 2018 10:18 am

alfaspider wrote:
Mon Dec 17, 2018 9:35 am
Epsilon Delta wrote:
Sun Dec 16, 2018 10:18 pm
Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".
I don't see how prepaying a mortgage is building wealth. You are simply transferring one investment (whatever investment the money you use to prepay is coming from), to another (home equity, and the imputed bond you are buying at the rate of the mortgage). If you are a standard BH 2/3 funder, it's effectively equivalent to re balancing your portfolio in favor of debt over equity.

It may or may not be the right decision, but the immediate impact on your net worth is zero.
I think they meant more paying down the mortgage from income. As in, they didn't have the money last month, now they do and make a choice between prepaying the mortgage or investing. Either way is building wealth then.

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Re: Pre-paying mortgage only in early years

Post by chevca » Mon Dec 17, 2018 10:27 am

TarHeel2002 wrote:
Mon Dec 17, 2018 9:26 am
I am wrestling with this question right now too. I am 6 years into a 30 year fixed rate mortgage 3.125%. Total balance due $151,750 and payments of $750/month. With the standard deduction rising my mortgage interest is no longer deductible. Beginning in January I am looking at:

A. Investing $1500-$2000/month into a taxable account (VTSAX)
B. Paying down the mortgage $1500-2000 month faster

I keep going back and forth on it. I am currently maxing out all tax advantaged retirement options available to me (401k, Roth, HSA). Some would say do a mix of both but I want to pick one an run with it. It's difficult because both sides appeal to me - paying off the mortgage early and watching the balance shrink every month. I also like the thought of watching a taxable account growing and increased liquidity beyond my emergency fund.
If both sides appeal to you, what's so difficult about it? Do some of both. :happy

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Re: Pre-paying mortgage only in early years

Post by LiterallyIronic » Mon Dec 17, 2018 10:30 am

We're in the early years of our mortgage, too. We got a 30-year fixed at 3.875% in September 2017. Every single month, I pay enough extra principal to make it so we pay more in principal than in interest. The first month, I had to pay an extra $260. The next month, I paid an extra $256. A year later, and I only paid an extra $220. Even despite this, we still only got the outstanding balance from $149,000 to $142,000 in a smidge over a year.

Of course, I don't pre-pay the mortgage in lieu of investing. I figured out how much we need to invest every month in order to have the amount we want by the time we want it (assuming 7% growth) and we invest that amount. So we do that and we hit the mortgage with extra. I didn't realize how much I'd hate having a mortgage, but I do. I'll feel better about it, I think, when the outstanding balance reaches $99,999, so the sooner we can get to that, the better.

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Re: Pre-paying mortgage only in early years

Post by vineviz » Mon Dec 17, 2018 10:33 am

Jags4186 wrote:
Mon Dec 17, 2018 9:37 am
At 3.125% I would hold onto it as long as possible. I mean I know we can be conservative on this website, but do you really believe that over the next 24 years your investments will return less than 3.125%?
This is what I think too.

For one thing, I suspect that is a greater-than-0% chance that the mortgage interest will become deductible again at some point.

But even without that factor, I think the odds of not being able to beat 3.125% with a balanced portfolio (e.g. 50%-60% stocks) over a 24-year period are miniscule even after taxes.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

chevca
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Re: Pre-paying mortgage only in early years

Post by chevca » Mon Dec 17, 2018 10:34 am

To the OPs question, yes, prepaying heavily towards the beginning of the mortgage will save the most in total interest paid. The sooner you pay down the balance, the less one pays in total interest. There's no magic to it, it's really that simple.

Whether to do that for the fist half and then stop... I'd say if one wants to pay the mortgage down to save total interest, then just keep doing that and get it knocked out. If one wants to stop prepaying later on to put more in investments, well, probably should have done that all along. Just my take on it though.

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Re: Pre-paying mortgage only in early years

Post by ryman554 » Mon Dec 17, 2018 10:37 am

alfaspider wrote:
Mon Dec 17, 2018 9:35 am
Epsilon Delta wrote:
Sun Dec 16, 2018 10:18 pm
Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".
I don't see how prepaying a mortgage is building wealth. You are simply transferring one investment (whatever investment the money you use to prepay is coming from), to another (home equity, and the imputed bond you are buying at the rate of the mortgage). If you are a standard BH 2/3 funder, it's effectively equivalent to re balancing your portfolio in favor of debt over equity.

It may or may not be the right decision, but the immediate impact on your net worth is zero.
Not quite. The immediate (and short-term future) impact on cash-flow is zero. Liquid funds is net negative. And, yes, on the day of doing the pre-payment, the impact toward net worth is zero.

It is building future wealth in the sense that future mortgage payments are less interest, so there is less drag on net worth in the future. At others have said, it is mostly equivalent to purchasing a bond of the remaining mortgage duration of the interest rate of the mortgage (modulo tax implications). And is 100% guaranteed in terms of rate of return.

There is no question that is it positive impact to *nominal* net worth as of the next month, which I'll call mostly immediate. Whether it is positive to *real* net worth depends on the personal rate of inflation and the mortgage interest rate. Whether it is optimal depends on the (unknown) returns on other investments that could have been done with that money, which can only be done in hindsight. For pre-paying early in the mortgage, it is likely, but not guaranteed, that the opportunity cost of not investing in equities is larger than the pre-payment bonus. Conversely, pre-payment of the mortgage becomes a better deal as the mortgage term nears it's completion, even though the interest savings is lower, because guaranteed nature of the return vs. the equity return uncertanty..

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Re: Pre-paying mortgage only in early years

Post by KlangFool » Mon Dec 17, 2018 10:42 am

TarHeel2002 wrote:
Mon Dec 17, 2018 9:26 am
I am wrestling with this question right now too. I am 6 years into a 30 year fixed rate mortgage 3.125%. Total balance due $151,750 and payments of $750/month. With the standard deduction rising my mortgage interest is no longer deductible. Beginning in January I am looking at:
TarHeel2002,

1) If you do not think that your portfolio can return greater than on the average of 3.125% annually over the next 24 years, why are you investing at all?

2) You have 2 choices:

A) Prepaying 3.125% mortgage with $1,500 to $2,000 per month.

B) Investing $1,500 to $2,000 per month. And, when the amount is big enough, pay off the whole mortgage in one lump sum.

Which method do you think will pay off the mortgage faster? (A) or (B)?

The obvious answer is (B). If you choose (A), why do you invest in your portfolio at all?

KlangFool

P.S.: It does not have to be 100% stock. Yes, you put all your money in the taxable account to 100% stock. But, you could increase your fixed income/bond on your tax-advantaged account. As a result, your new money would be invested in 60/40 instead of 100/0.
Last edited by KlangFool on Mon Dec 17, 2018 10:55 am, edited 3 times in total.

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Re: Pre-paying mortgage only in early years

Post by Admiral » Mon Dec 17, 2018 10:43 am

30investor wrote:
Sun Dec 16, 2018 9:27 pm
I have searched for this topic and haven't found it some I'm probably missing some obvious reason why it doesn't make sense. But given the amortization schedule of a mortgage would there be an argument to pre-pay heavily for the first 50-75% of the life of the mortgage when 50-60% of your payments are going to interest and then stopping for the later years when the majority of your payments are principal anyway and presumably inflation has devalued the mortgage amount anyway? I realize doing this delays the cash flow boost of having the mortgage paid off. It also knocks out the interest early which lessens the tax deduction but the deduction isn't a dollar for dollar tradeoff anyway. What am I missing or not considering?

This is a general question so I don't know that the specific stats matter but I have a 3.75% 30 year fixed mortgage that I owe about $255K on. I'm about 3.5 years in but I've prepaid from time to time already so I'd need to rerun the numbers to find my current payoff date.
There's no set answer because each person's mortgage is different (not to mention things like how long they plan to keep the house.)

As a general rule, if the interest rate spread is advantageous, you'd be better off refinancing to a 15 year mortgage than pre-paying on a 30. The reason is that even with pre-payment, you're still only knocking down the principal at the 30 year rate. A 15 year amortization typically will have a higher payment but a lower rate, and the effect is that more principal is being paid with each payment, and a lower interest rate applied the remaining balance.

You should shop rates and then run the loans that are available through a mortgage calculator. A quick search shows that 15 year rates are still well below 4%. However, since your rate is pretty low even in comparison, you'd have to run the numbers.

EDIT: Also keep in mind that inflation has a large effect on the value of the dollar. As long as your income keeps up with inflation, your mortgage payment will become a smaller and smaller slice of your budget. And future dollars are worth less than current ones, because current ones can be invested. Saving $20,000 in 20 years is not the same as saving/spending/investing $20,000 today.
Last edited by Admiral on Mon Dec 17, 2018 10:46 am, edited 1 time in total.

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Re: Pre-paying mortgage only in early years

Post by Flyer24 » Mon Dec 17, 2018 10:44 am

alfaspider wrote:
Mon Dec 17, 2018 9:35 am
Epsilon Delta wrote:
Sun Dec 16, 2018 10:18 pm
Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".
I don't see how prepaying a mortgage is building wealth. You are simply transferring one investment (whatever investment the money you use to prepay is coming from), to another (home equity, and the imputed bond you are buying at the rate of the mortgage). If you are a standard BH 2/3 funder, it's effectively equivalent to re balancing your portfolio in favor of debt over equity.

It may or may not be the right decision, but the immediate impact on your net worth is zero.
It depends on where the money is coming from. If he is transferring from an investment then it is zero. However, if it is from extra income then it does increase your net worth. I took the question as coming from extra income.

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Re: Pre-paying mortgage only in early years

Post by alfaspider » Mon Dec 17, 2018 10:49 am

Flyer24 wrote:
Mon Dec 17, 2018 10:44 am
alfaspider wrote:
Mon Dec 17, 2018 9:35 am
Epsilon Delta wrote:
Sun Dec 16, 2018 10:18 pm
Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".
I don't see how prepaying a mortgage is building wealth. You are simply transferring one investment (whatever investment the money you use to prepay is coming from), to another (home equity, and the imputed bond you are buying at the rate of the mortgage). If you are a standard BH 2/3 funder, it's effectively equivalent to re balancing your portfolio in favor of debt over equity.

It may or may not be the right decision, but the immediate impact on your net worth is zero.
It depends on where the money is coming from. If he is transferring from an investment then it is zero. However, if it is from extra income then it does increase your net worth. I took the question as coming from extra income.
The increase in net worth comes from the income itself, not from putting the income into the mortgage.

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Epsilon Delta
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Re: Pre-paying mortgage only in early years

Post by Epsilon Delta » Mon Dec 17, 2018 11:28 am

stan1 wrote:
Sun Dec 16, 2018 10:03 pm
I would save for retirement first (max out 401Ks and IRAs), build up a low six figure taxable account, and then only after that consider paying down a mortgage early with one or two extra payments per year. Build your wealth. Housing is an expense since we have to live somewhere and I don't mind treating a mortgage as an expense rather than a liability. Most people's income grows in their 30s and 40s and disposable incomes grow after kids are out of college. Pay off the mortgage then.
Epsilon Delta wrote:
Sun Dec 16, 2018 10:18 pm
Prepaying a mortgage is building your wealth. It is more or less equivalent to buying a bond, and for net worth purposes more "more" than "less".
The various responses that amount to "buying an investment is not increasing your net worth, it is just moving money from one pocket to another" are far more relevant to the first than the second, yet it got no such responses.

For the record -- paying off a house, so you have no* mortgage payments in retirement is a reasonable, if not optimal way of saving for retirement.

* Or fewer for the nitpickers.

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Re: Pre-paying mortgage only in early years

Post by nolesrule » Mon Dec 17, 2018 11:52 am

This is where you put the personal in personal finance. I have the same mortgage rate. We pay extra to feel like we're doing something, but not so much because the majority of our extra funds are going into tax efficient investments in a taxable account with long term expected higher growth.

We round up the payment to the next $50 increment and add in a sliver of any leftover money at the end of the month. In a month with a third paycheck, we add a little more, but again, not much. Being the analytical type, this satisfies the need to do something without constantly tinkering.

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Re: Pre-paying mortgage only in early years

Post by willthrill81 » Mon Dec 17, 2018 12:07 pm

Jags4186 wrote:
Mon Dec 17, 2018 9:37 am
TarHeel2002 wrote:
Mon Dec 17, 2018 9:26 am
I am wrestling with this question right now too. I am 6 years into a 30 year fixed rate mortgage 3.125%. Total balance due $151,750 and payments of $750/month. With the standard deduction rising my mortgage interest is no longer deductible. Beginning in January I am looking at:

A. Investing $1500-$2000/month into a taxable account (VTSAX)
B. Paying down the mortgage $1500-2000 month faster

I keep going back and forth on it. I am currently maxing out all tax advantaged retirement options available to me (401k, Roth, HSA). Some would say do a mix of both but I want to pick one an run with it. It's difficult because both sides appeal to me - paying off the mortgage early and watching the balance shrink every month. I also like the thought of watching a taxable account growing and increased liquidity beyond my emergency fund.
At 3.125% I would hold onto it as long as possible. I mean I know we can be conservative on this website, but do you really believe that over the next 24 years your investments will return less than 3.125%?
I certainly hope not, but the situation might be more complex than that. There are a lot of Bogleheads holding fixed income instruments with a yield below 3.125%, and there's no guarantee that that will rise in the future. Apart from liquidity and rebalancing purposes, your argument is basically against holding any fixed income investments right now.

Inverting the decision can sometimes be helpful when deciding what to do. If your house was paid off, would you choose to take out a mortgage to invest the borrowed proceeds, using your home equity as investment leverage? Granted, this is not a precise reversal of the decision, but the basic principle is still there. Some here would definitely go for that, and some would not. It's a personal decision.

Despite our mortgage rate being very similar to that, we've decided to pay ours off early in order to hedge our bets. Primarily, we're doing so to reduce our fixed expenses going forward in case of a dramatic change in my employment situation (we're a single-income household). Also, we're very aggressive with our investment portfolio, and paying off the mortgage counterbalances that somewhat.

We've thought about creating a sinking fund for paying off the mortgage, but we don't need the liquidity that would provide within the time frame we have left to pay off the mortgage (only 16 months, and my current employment contract goes beyond that anyway), and our mortgage rate is higher than anything we could earn with the sinking fund, so we're just paying down the mortgage directly.

There are many ways to attack this issue, and there are many reasonable solutions IMHO. A lot of it comes down to personal circumstances and motivations.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Pre-paying mortgage only in early years

Post by Jags4186 » Mon Dec 17, 2018 1:01 pm

Willthrill81,

I don’t think paying off a low interest rate mortgage quickly is a bad idea. I think it is sub optimal. But that can only be known in hindsight. If I had to guess which one would have him having more money in 24 years, I would wager paying monthly and investing the difference versus prepaying the mortgage. The benefit of holding bonds is that they are not as volatile as stocks and not highly correlated to stocks. The benefit of having a mortgage is the ability to leverage an asset with a low interest, long duration, uncallable loan.
willthrill81 wrote:
Mon Dec 17, 2018 12:07 pm
Inverting the decision can sometimes be helpful when deciding what to do. If your house was paid off, would you choose to take out a mortgage to invest the borrowed proceeds, using your home equity as investment leverage? Granted, this is not a precise reversal of the decision, but the basic principle is still there. Some here would definitely go for that, and some would not. It's a personal decision.
I would like to address this one point you made though. “Inverting the decision” only matters if you are in a position where you can invert the decision. I do not see it as a helpful thought exercise, in fact I believe it can lead you to making a poor decision. It is frequently brought up and I only first heard about it when it comes to prepaying your mortgage from Dave Ramsey so that’s where I assume you get it from.

Let’s look at this particular scenario. OP is in a position where he can either pay $1500/mo more on his mortgage payment every month, or invest $1500 a month. He is not in a position of having a paid off house which he can mortgage nor does he have a taxable account with funds available to immediately pay off the house. If OP chooses to accelerate payments to pay off his house quicker his $1500/mo is essentially gone until the house is completely paid off, he gains $1500+mortgage payment cash flow, or sold, getting his return of equity. He gains no benefit to prepaying other than reducing number of payments he has to make many years in the future and lowering the total cost of the loan. If the OP saves this $1500 a month until he can lump sum pay off his loan then he can make the decision—do I want to carry this mortgage and have money in the bank or do I want to pay off the mortgage and eliminate a monthly expense.

Your home has basically two states—mortgaged or paid off, payment or no payment. Ignoring refinance scenarios, that payment is set at origination and doesn’t change unless you completely pay off the house. You say you are prepaying your mortgage to reduce your fixed expenses going forward in order to mitigate damages from job loss. Prepaying your mortgage reduces your fixed expenses $0 going forward unless you pay off the loan. If you are on track to pay off a 30 year mortgage in 10 years and lose your job in year 4, all that prepayment has done nothing to help your situation.

Now there is a scenario where prepaying with a very low rate makes sense. If you are going to piss away the money on toys instead of investing it, then you definitely should consider prepaying as it is forced savings.

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Re: Pre-paying mortgage only in early years

Post by fulltilt » Mon Dec 17, 2018 1:49 pm

Jags4186 wrote:
Mon Dec 17, 2018 1:01 pm
Willthrill81,

I don’t think paying off a low interest rate mortgage quickly is a bad idea. I think it is sub optimal. But that can only be known in hindsight. If I had to guess which one would have him having more money in 24 years, I would wager paying monthly and investing the difference versus prepaying the mortgage. The benefit of holding bonds is that they are not as volatile as stocks and not highly correlated to stocks. The benefit of having a mortgage is the ability to leverage an asset with a low interest, long duration, uncallable loan.
Sub-optimal only if the variable you're optimizing against is return.
Jags4186 wrote:
Mon Dec 17, 2018 1:01 pm
Let’s look at this particular scenario. OP is in a position where he can either pay $1500/mo more on his mortgage payment every month, or invest $1500 a month. He is not in a position of having a paid off house which he can mortgage nor does he have a taxable account with funds available to immediately pay off the house. If OP chooses to accelerate payments to pay off his house quicker his $1500/mo is essentially gone until the house is completely paid off, he gains $1500+mortgage payment cash flow, or sold, getting his return of equity. He gains no benefit to prepaying other than reducing number of payments he has to make many years in the future and lowering the total cost of the loan. If the OP saves this $1500 a month until he can lump sum pay off his loan then he can make the decision—do I want to carry this mortgage and have money in the bank or do I want to pay off the mortgage and eliminate a monthly expense.
Accelerated payments are certainly not 'gone', the return is immediate and risk free. The return is in the reduction of interest paid each month. That is real money.
Jags4186 wrote:
Mon Dec 17, 2018 1:01 pm
Your home has basically two states—mortgaged or paid off, payment or no payment. Ignoring refinance scenarios, that payment is set at origination and doesn’t change unless you completely pay off the house. You say you are prepaying your mortgage to reduce your fixed expenses going forward in order to mitigate damages from job loss. Prepaying your mortgage reduces your fixed expenses $0 going forward unless you pay off the loan. If you are on track to pay off a 30 year mortgage in 10 years and lose your job in year 4, all that prepayment has done nothing to help your situation.
Saying a mortgage only has two states isn't really correct. Certainly, payment or no-payment matters, but the balance on the mortgage matters too. A lower balance gives you options and flexibility. For example, you can take out a HELOC, you can recast a mortgage, or if you decide to move, you can use the equity in your house as a down payment on a future house. In your specific example, lets say that OP does lose his job after 4 years, if he has been only paying the minimum and investing the rest, then what happens when he needs to relocate but he can't because he is upside down on his house?

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Re: Pre-paying mortgage only in early years

Post by Admiral » Mon Dec 17, 2018 1:59 pm

Jags4186 wrote:
Mon Dec 17, 2018 1:01 pm
Willthrill81,

I don’t think paying off a low interest rate mortgage quickly is a bad idea. I think it is sub optimal. But that can only be known in hindsight. If I had to guess which one would have him having more money in 24 years, I would wager paying monthly and investing the difference versus prepaying the mortgage. The benefit of holding bonds is that they are not as volatile as stocks and not highly correlated to stocks. The benefit of having a mortgage is the ability to leverage an asset with a low interest, long duration, uncallable loan.
willthrill81 wrote:
Mon Dec 17, 2018 12:07 pm
Inverting the decision can sometimes be helpful when deciding what to do. If your house was paid off, would you choose to take out a mortgage to invest the borrowed proceeds, using your home equity as investment leverage? Granted, this is not a precise reversal of the decision, but the basic principle is still there. Some here would definitely go for that, and some would not. It's a personal decision.
I would like to address this one point you made though. “Inverting the decision” only matters if you are in a position where you can invert the decision. I do not see it as a helpful thought exercise, in fact I believe it can lead you to making a poor decision. It is frequently brought up and I only first heard about it when it comes to prepaying your mortgage from Dave Ramsey so that’s where I assume you get it from.

Let’s look at this particular scenario. OP is in a position where he can either pay $1500/mo more on his mortgage payment every month, or invest $1500 a month. He is not in a position of having a paid off house which he can mortgage nor does he have a taxable account with funds available to immediately pay off the house. If OP chooses to accelerate payments to pay off his house quicker his $1500/mo is essentially gone until the house is completely paid off, he gains $1500+mortgage payment cash flow, or sold, getting his return of equity. He gains no benefit to prepaying other than reducing number of payments he has to make many years in the future and lowering the total cost of the loan. If the OP saves this $1500 a month until he can lump sum pay off his loan then he can make the decision—do I want to carry this mortgage and have money in the bank or do I want to pay off the mortgage and eliminate a monthly expense.

Your home has basically two states—mortgaged or paid off, payment or no payment. Ignoring refinance scenarios, that payment is set at origination and doesn’t change unless you completely pay off the house. You say you are prepaying your mortgage to reduce your fixed expenses going forward in order to mitigate damages from job loss. Prepaying your mortgage reduces your fixed expenses $0 going forward unless you pay off the loan. If you are on track to pay off a 30 year mortgage in 10 years and lose your job in year 4, all that prepayment has done nothing to help your situation.

Now there is a scenario where prepaying with a very low rate makes sense. If you are going to piss away the money on toys instead of investing it, then you definitely should consider prepaying as it is forced savings.
+1. I agree, and I've tried to point out many times the fallacy of this logic problem. It's a false equivalence. In many if not most cases, if one has extra money AND one has a low rate, one is better served by investing, assuming a long enough time horizon. If one is dead-set on putting more money into the house, then refinancing to a lower rate/term (even an ARM, if one is certain to have the loan fully repaid before a reset) is almost always a better option than pre-payment on a higher rate loan. It's just math. Things get trickier depending on the rate spread and the refinancing cost.

But as long as you know you will have the extra money to make a larger payment, a refi is the better deal. There's also the added benefit of building equity more quickly, just in case one is forced to sell before the loan is paid off.

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Re: Pre-paying mortgage only in early years

Post by topper1296 » Mon Dec 17, 2018 2:07 pm

I've rounded my mortgage payment up to the nearest $100 increment. Works out to be about one extra payment per year on a 15 year loan @ 3.375%.

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Re: Pre-paying mortgage only in early years

Post by vineviz » Mon Dec 17, 2018 2:12 pm

fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Accelerated payments are certainly not 'gone', the return is immediate and risk free. The return is in the reduction of interest paid each month. That is real money.
It's "gone" in the sense that prepayment is a mechanism to convert what is the most liquid class of asset that most people own (cash) into the least liquid class of asset most people own (real estate).
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Jags4186 wrote:
Mon Dec 17, 2018 1:01 pm
Your home has basically two states—mortgaged or paid off, payment or no payment. Ignoring refinance scenarios, that payment is set at origination and doesn’t change unless you completely pay off the house. You say you are prepaying your mortgage to reduce your fixed expenses going forward in order to mitigate damages from job loss. Prepaying your mortgage reduces your fixed expenses $0 going forward unless you pay off the loan. If you are on track to pay off a 30 year mortgage in 10 years and lose your job in year 4, all that prepayment has done nothing to help your situation.
Saying a mortgage only has two states isn't really correct. Certainly, payment or no-payment matters, but the balance on the mortgage matters too. A lower balance gives you options and flexibility. For example, you can take out a HELOC, you can recast a mortgage, or if you decide to move, you can use the equity in your house as a down payment on a future house. In your specific example, lets say that OP does lose his job after 4 years, if he has been only paying the minimum and investing the rest, then what happens when he needs to relocate but he can't because he is upside down on his house?


This is all well-and-good if the economy is great. People who bought homes in 2002, with mortgage rates at 6.5%, and spent the next five years paying down additional principal on their loans likely felt the same way. If those people lost their jobs in 2009, they certainly wished they had that money in a brokerage account because extracting their home equity in those circumstances was nearly impossible for many homeowners.

I certainly would never say that pre-paying a mortgage is always, or even usually, a bad idea. I do think people need to be careful not to put themselves into a liquidity trap from which they can't escape AND that could have been easily avoided.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Pre-paying mortgage only in early years

Post by Gretchen » Mon Dec 17, 2018 2:20 pm

When we were working, we each maxed out our 401(K) and then threw a few extra dollars at the mortgage every month. We have an old ARM with four years to go, taken out before they figured out how to make them abusive. Instead of shortening the duration as with a fixed-rate mortgage, extra payments cause the payment to go down once a year at recalculation time, but leave the duration intact. Our payment is down to $432 a month, rounded up to $450 per our habit, and that fits nicely into our retirement budget. Not sorry.

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Re: Pre-paying mortgage only in early years

Post by fulltilt » Mon Dec 17, 2018 2:39 pm

vineviz wrote:
Mon Dec 17, 2018 2:12 pm
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Accelerated payments are certainly not 'gone', the return is immediate and risk free. The return is in the reduction of interest paid each month. That is real money.
It's "gone" in the sense that prepayment is a mechanism to convert what is the most liquid class of asset that most people own (cash) into the least liquid class of asset most people own (real estate).
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Jags4186 wrote:
Mon Dec 17, 2018 1:01 pm
Your home has basically two states—mortgaged or paid off, payment or no payment. Ignoring refinance scenarios, that payment is set at origination and doesn’t change unless you completely pay off the house. You say you are prepaying your mortgage to reduce your fixed expenses going forward in order to mitigate damages from job loss. Prepaying your mortgage reduces your fixed expenses $0 going forward unless you pay off the loan. If you are on track to pay off a 30 year mortgage in 10 years and lose your job in year 4, all that prepayment has done nothing to help your situation.
Saying a mortgage only has two states isn't really correct. Certainly, payment or no-payment matters, but the balance on the mortgage matters too. A lower balance gives you options and flexibility. For example, you can take out a HELOC, you can recast a mortgage, or if you decide to move, you can use the equity in your house as a down payment on a future house. In your specific example, lets say that OP does lose his job after 4 years, if he has been only paying the minimum and investing the rest, then what happens when he needs to relocate but he can't because he is upside down on his house?


This is all well-and-good if the economy is great. People who bought homes in 2002, with mortgage rates at 6.5%, and spent the next five years paying down additional principal on their loans likely felt the same way. If those people lost their jobs in 2009, they certainly wished they had that money in a brokerage account because extracting their home equity in those circumstances was nearly impossible for many homeowners.

I certainly would never say that pre-paying a mortgage is always, or even usually, a bad idea. I do think people need to be careful not to put themselves into a liquidity trap from which they can't escape AND that could have been easily avoided.
Drat, i knew i shouldn't have mentioned the HELOC. It detracted from my point, but I was trying to enumerate options that equity give you. A HELOC is a very poor line of defense for emergencies. I agree. ... Fair point about liquidity....

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Re: Pre-paying mortgage only in early years

Post by Jags4186 » Mon Dec 17, 2018 2:50 pm

vineviz wrote:
Mon Dec 17, 2018 2:12 pm
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Accelerated payments are certainly not 'gone', the return is immediate and risk free. The return is in the reduction of interest paid each month. That is real money.
It's "gone" in the sense that prepayment is a mechanism to convert what is the most liquid class of asset that most people own (cash) into the least liquid class of asset most people own (real estate).
+1 exactly.
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
In your specific example, lets say that OP does lose his job after 4 years, if he has been only paying the minimum and investing the rest, then what happens when he needs to relocate but he can't because he is upside down on his house?


He could use the money he had been saving instead of prepaying into the house to subsidize the sale.

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Re: Pre-paying mortgage only in early years

Post by KlangFool » Mon Dec 17, 2018 2:58 pm

Jags4186 wrote:
Mon Dec 17, 2018 2:50 pm
vineviz wrote:
Mon Dec 17, 2018 2:12 pm
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Accelerated payments are certainly not 'gone', the return is immediate and risk free. The return is in the reduction of interest paid each month. That is real money.
It's "gone" in the sense that prepayment is a mechanism to convert what is the most liquid class of asset that most people own (cash) into the least liquid class of asset most people own (real estate).
+1 exactly.
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
In your specific example, lets say that OP does lose his job after 4 years, if he has been only paying the minimum and investing the rest, then what happens when he needs to relocate but he can't because he is upside down on his house?


He could use the money he had been saving instead of prepaying into the house to subsidize the sale.
Jags4186,

Or, he could delay the sale for a while until the market recovered since he has the money.

KlangFool

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Re: Pre-paying mortgage only in early years

Post by celia » Mon Dec 17, 2018 3:06 pm

The first part of my decision would not even be financial. I would want the mortgage paid off before I retired, so I would look at the time remaining until my estimated retirement date. If the loan currently extends past that estimated date, I would start knocking months off.

The second part of my decision is financial. It is a lot cheaper to knock off a month by paying off a month in the early years instead of later. I would want to keep my required payments lower (ie, 30 year loan) than refinance into a shorter term loan as that provides some safety in case we would be laid off. (We were both laid off in the same month one time but could still pay our 30-year mortgage for over a year while living off of unemployment and savings.)

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Re: Pre-paying mortgage only in early years

Post by willthrill81 » Mon Dec 17, 2018 3:14 pm

vineviz wrote:
Mon Dec 17, 2018 2:12 pm
I certainly would never say that pre-paying a mortgage is always, or even usually, a bad idea. I do think people need to be careful not to put themselves into a liquidity trap from which they can't escape AND that could have been easily avoided.
I agree. That's why I think that unless you can pay off your mortgage in a fairly short period of time, you're better off creating a sinking fund with the cash you would have applied toward the mortgage. This maintains liquidity and eventually allows you to pay off the mortgage in one fail swoop. Or if you change your mind before paying off the mortgage, you can apply the funds toward something else entirely. The only real cost is the difference between your mortgage rate and the return on the sinking fund.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Pre-paying mortgage only in early years

Post by fulltilt » Mon Dec 17, 2018 3:16 pm

KlangFool wrote:
Mon Dec 17, 2018 2:58 pm
Jags4186 wrote:
Mon Dec 17, 2018 2:50 pm
vineviz wrote:
Mon Dec 17, 2018 2:12 pm
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Accelerated payments are certainly not 'gone', the return is immediate and risk free. The return is in the reduction of interest paid each month. That is real money.
It's "gone" in the sense that prepayment is a mechanism to convert what is the most liquid class of asset that most people own (cash) into the least liquid class of asset most people own (real estate).
+1 exactly.
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
In your specific example, lets say that OP does lose his job after 4 years, if he has been only paying the minimum and investing the rest, then what happens when he needs to relocate but he can't because he is upside down on his house?


He could use the money he had been saving instead of prepaying into the house to subsidize the sale.
Jags4186,

Or, he could delay the sale for a while until the market recovered since he has the money.

KlangFool
We don't all have 4,000 years of emergency fund saved up like you KlangFool. :P .... Sure, you could save that money and use it to subsidize the sale, but if OP has 3.75% interest on his mortgage, then he probably needs about 5% pretax rate of return to get an equivalent post tax rate of return. Paying off a chunk of the house to get a risk free return and to guard yourself against the possibility of being underwater when the sugar hits the fan seems reasonable to me. My original point was that paying off a *part* of the mortgage can give you flexibility even if it costs you liquidity (if that makes sense) and that it doesn't have to be an all or nothing thing.

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Re: Pre-paying mortgage only in early years

Post by willthrill81 » Mon Dec 17, 2018 3:25 pm

Jags4186 wrote:
Mon Dec 17, 2018 1:01 pm
willthrill81 wrote:
Mon Dec 17, 2018 12:07 pm
Inverting the decision can sometimes be helpful when deciding what to do. If your house was paid off, would you choose to take out a mortgage to invest the borrowed proceeds, using your home equity as investment leverage? Granted, this is not a precise reversal of the decision, but the basic principle is still there. Some here would definitely go for that, and some would not. It's a personal decision.
I would like to address this one point you made though. “Inverting the decision” only matters if you are in a position where you can invert the decision. I do not see it as a helpful thought exercise, in fact I believe it can lead you to making a poor decision. It is frequently brought up and I only first heard about it when it comes to prepaying your mortgage from Dave Ramsey so that’s where I assume you get it from.
Not necessarily. That's a matter of opinion. As I said, the inversion is not a perfect one, but it can still be useful. And no, I didn't get the notion from DR.
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Re: Pre-paying mortgage only in early years

Post by KlangFool » Mon Dec 17, 2018 3:26 pm

fulltilt wrote:
Mon Dec 17, 2018 3:16 pm
KlangFool wrote:
Mon Dec 17, 2018 2:58 pm
Jags4186 wrote:
Mon Dec 17, 2018 2:50 pm
vineviz wrote:
Mon Dec 17, 2018 2:12 pm
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
Accelerated payments are certainly not 'gone', the return is immediate and risk free. The return is in the reduction of interest paid each month. That is real money.
It's "gone" in the sense that prepayment is a mechanism to convert what is the most liquid class of asset that most people own (cash) into the least liquid class of asset most people own (real estate).
+1 exactly.
fulltilt wrote:
Mon Dec 17, 2018 1:49 pm
In your specific example, lets say that OP does lose his job after 4 years, if he has been only paying the minimum and investing the rest, then what happens when he needs to relocate but he can't because he is upside down on his house?


He could use the money he had been saving instead of prepaying into the house to subsidize the sale.
Jags4186,

Or, he could delay the sale for a while until the market recovered since he has the money.

KlangFool
We don't all have 4,000 years of emergency fund saved up like you KlangFool. :P .... Sure, you could save that money and use it to subsidize the sale, but if OP has 3.75% interest on his mortgage, then he probably needs about 5% pretax rate of return to get an equivalent post tax rate of return.
fulltilt,

If a person has no confidence that his 60/40 portfolio could return at least on the average of nominal annual 5% over the next 10 to 20 years, why invest at all? Just pre-pay the mortgage instead of investing any money.

<<We don't all have 4,000 years of emergency fund saved up like you KlangFool. >>

Then, it is even more essential that do not tie up more of your money in the illiquid house.

KlangFool

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Re: Pre-paying mortgage only in early years

Post by fulltilt » Mon Dec 17, 2018 3:48 pm

KlangFool wrote:
Mon Dec 17, 2018 3:26 pm

fulltilt,

If a person has no confidence that his 60/40 portfolio could return at least on the average of nominal annual 5% over the next 10 to 20 years, why invest at all? Just pre-pay the mortgage instead of investing any money.
I invest because i don't know what the future holds. Vanguard is projecting the median return of 60/40 portfolio over the next 10 years will be 4.9%. Investing certainly isn't a slam dunk, but i think it is probably better to invest than pay down the mortgage.
KlangFool wrote:
Mon Dec 17, 2018 3:26 pm

<<We don't all have 4,000 years of emergency fund saved up like you KlangFool. >>

Then, it is even more essential that do not tie up more of your money in the illiquid house.

KlangFool
Ha! Well played sir. Well played. :sharebeer

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Re: Pre-paying mortgage only in early years

Post by vineviz » Mon Dec 17, 2018 3:51 pm

willthrill81 wrote:
Mon Dec 17, 2018 3:14 pm
vineviz wrote:
Mon Dec 17, 2018 2:12 pm
I certainly would never say that pre-paying a mortgage is always, or even usually, a bad idea. I do think people need to be careful not to put themselves into a liquidity trap from which they can't escape AND that could have been easily avoided.
I agree. That's why I think that unless you can pay off your mortgage in a fairly short period of time, you're better off creating a sinking fund with the cash you would have applied toward the mortgage. This maintains liquidity and eventually allows you to pay off the mortgage in one fail swoop. Or if you change your mind before paying off the mortgage, you can apply the funds toward something else entirely. The only real cost is the difference between your mortgage rate and the return on the sinking fund.
In principle, it should be possible to estimate an illiquidity premium that should be added to a tax-equivalent mortgage rate when evaluating the prepayment decision.

In other words, the hurdle rate an investor should demand from nominal investment can be lower than the after-tax rate of the mortgage by some amount to compensate for the illiquidity associated with a home equity.

I’d like to spend more time thinking about it, but it’s not hard to get to a number like 40bps or 50 bps.

Which is to say, it’s probably only rational to prepay a mortgage if the interest rate on the mortgage exceeds the expected investment return by 0.4% or more. Both numbers adjusted for taxes of course.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: Pre-paying mortgage only in early years

Post by fulltilt » Mon Dec 17, 2018 4:17 pm

vineviz wrote:
Mon Dec 17, 2018 3:51 pm
willthrill81 wrote:
Mon Dec 17, 2018 3:14 pm
vineviz wrote:
Mon Dec 17, 2018 2:12 pm
I certainly would never say that pre-paying a mortgage is always, or even usually, a bad idea. I do think people need to be careful not to put themselves into a liquidity trap from which they can't escape AND that could have been easily avoided.
I agree. That's why I think that unless you can pay off your mortgage in a fairly short period of time, you're better off creating a sinking fund with the cash you would have applied toward the mortgage. This maintains liquidity and eventually allows you to pay off the mortgage in one fail swoop. Or if you change your mind before paying off the mortgage, you can apply the funds toward something else entirely. The only real cost is the difference between your mortgage rate and the return on the sinking fund.
In principle, it should be possible to estimate an illiquidity premium that should be added to a tax-equivalent mortgage rate when evaluating the prepayment decision.

In other words, the hurdle rate an investor should demand from nominal investment can be lower than the after-tax rate of the mortgage by some amount to compensate for the illiquidity associated with a home equity.

I’d like to spend more time thinking about it, but it’s not hard to get to a number like 40bps or 50 bps.

Which is to say, it’s probably only rational to prepay a mortgage if the interest rate on the mortgage exceeds the expected investment return by 0.4% or more. Both numbers adjusted for taxes of course.
Isn't that kind of where we are at today? If someone bought a house with a 30 year mortgage at 4.75% vs a 30 year treasury at 3.14%? Or would you use some other investment? or am i misunderstanding you entirely....

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Re: Pre-paying mortgage only in early years

Post by willthrill81 » Mon Dec 17, 2018 4:25 pm

vineviz wrote:
Mon Dec 17, 2018 3:51 pm
Which is to say, it’s probably only rational to prepay a mortgage if the interest rate on the mortgage exceeds the expected investment return by 0.4% or more. Both numbers adjusted for taxes of course.
There can be rational reasons that have nothing to do with the difference between the mortgage rate and the expected investment return. Improving cash flow is one.

Further, we cannot ignore that with many, if not most, investments, there is variance around the expected return, which also impacts the decision.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Pre-paying mortgage only in early years

Post by Epsilon Delta » Mon Dec 17, 2018 4:26 pm

Although liquidity is important there is a point of diminishing returns. Once the basis in our Roths was larger than the mortgage I felt I had gone well past that point and could decide to pay off or invest based by comparing the mortgage and bond rates.

Carrying excess liquidity is insuring against very rare events. There are usually other, more common, events where the insurance premium could be better spent. Aiming for higher returns, and hence a higher net worth is in some measure buying insurance against everything.

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Re: Pre-paying mortgage only in early years

Post by GerryL » Mon Dec 17, 2018 4:35 pm

nolesrule wrote:
Mon Dec 17, 2018 11:52 am
This is where you put the personal in personal finance. I have the same mortgage rate. We pay extra to feel like we're doing something, but not so much because the majority of our extra funds are going into tax efficient investments in a taxable account with long term expected higher growth.

We round up the payment to the next $50 increment and add in a sliver of any leftover money at the end of the month. In a month with a third paycheck, we add a little more, but again, not much. Being the analytical type, this satisfies the need to do something without constantly tinkering.
Yes. Personal. From the first I set up with the mortgage company to automatically add an extra $100 to my autopayment to apply to principal. This only came after fully funding retirement accounts and some additional savings and investments. When I was unemployed, of course, the extra payments were stopped, but I restarted them when I got a new, steady job and increased to $150 a month when I refinanced to a 15-year mortgage. Eventually stopped the extra payments after 2008-2009 made my income (but not my expenses) stagnate. I would never sign up for the bank's offer of a "pay off your mortgage quicker" plan. Doing it on your own gives you the flexibility to stop making extra payments when it no longer makes sense in your situation.

PS Ended up paying off mortgage a few months before accepting an offer to retire a year earlier than planned. I was helped by a gift from my elderly aunt who wanted to help me pay off the mortgage. (But don't tell your cousins.) Thanks to the timing, in the front half of the mortgage life, I was able to tell her that her gift shortened the mortgage by a year.

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Re: Pre-paying mortgage only in early years

Post by KlangFool » Mon Dec 17, 2018 4:44 pm

Epsilon Delta wrote:
Mon Dec 17, 2018 4:26 pm
Although liquidity is important there is a point of diminishing returns. Once the basis in our Roths was larger than the mortgage I felt I had gone well past that point and could decide to pay off or invest based by comparing the mortgage and bond rates.

Carrying excess liquidity is insuring against very rare events. There are usually other, more common, events where the insurance premium could be better spent. Aiming for higher returns, and hence a higher net worth is in some measure buying insurance against everything.
Epsilon Delta,

<<Carrying excess liquidity is insuring against very rare events. >>

There are 2 dimensions to risk: probability and severity. Just because it is rare, it is not a sufficient reason not to insure against that risk if the severity is high enough.

KlangFool

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Re: Pre-paying mortgage only in early years

Post by vineviz » Mon Dec 17, 2018 4:52 pm

willthrill81 wrote:
Mon Dec 17, 2018 4:25 pm
vineviz wrote:
Mon Dec 17, 2018 3:51 pm
Which is to say, it’s probably only rational to prepay a mortgage if the interest rate on the mortgage exceeds the expected investment return by 0.4% or more. Both numbers adjusted for taxes of course.
There can be rational reasons that have nothing to do with the difference between the mortgage rate and the expected investment return. Improving cash flow is one.

Further, we cannot ignore that with many, if not most, investments, there is variance around the expected return, which also impacts the decision.
"Improving cash flow" is a bit indeterminate as a goal, but it seems likely that it would be related to the the liquidity premium the investor would demand.

I'm not sure what to do with the second point. I guess you're driving at risk aversion, such that an investor might prefer an investment with an expected return of 2% with a 0% variance over an investment with an expected return of 3% and a variance of 2%. If that's what you mean, then I guess I'd say "yeah". Different investors have different utility functions, and that will likely impact the liquidity premium those investors will demand. I'd describe a preference for less risky investments more as a matter of taste, because to me being willing to accept a 2% return instead of a 3% return is a question of arbitrage not taste. But maybe I'm not getting at the point you're making?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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jriding
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Re: Pre-paying mortgage only in early years

Post by jriding » Mon Dec 17, 2018 5:07 pm

chevca wrote:
Mon Dec 17, 2018 10:27 am
TarHeel2002 wrote:
Mon Dec 17, 2018 9:26 am
I am wrestling with this question right now too. I am 6 years into a 30 year fixed rate mortgage 3.125%. Total balance due $151,750 and payments of $750/month. With the standard deduction rising my mortgage interest is no longer deductible. Beginning in January I am looking at:

A. Investing $1500-$2000/month into a taxable account (VTSAX)
B. Paying down the mortgage $1500-2000 month faster

I keep going back and forth on it. I am currently maxing out all tax advantaged retirement options available to me (401k, Roth, HSA). Some would say do a mix of both but I want to pick one an run with it. It's difficult because both sides appeal to me - paying off the mortgage early and watching the balance shrink every month. I also like the thought of watching a taxable account growing and increased liquidity beyond my emergency fund.
If both sides appeal to you, what's so difficult about it? Do some of both. :happy
We were wrestling with the same question a few years ago and did exactly what chevca suggests: we split the difference 50-50 to mortgage and savings. Looking back it feels like we made the right decision and we plan to continue with this strategy going forward.

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Epsilon Delta
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Re: Pre-paying mortgage only in early years

Post by Epsilon Delta » Mon Dec 17, 2018 5:18 pm

KlangFool wrote:
Mon Dec 17, 2018 4:44 pm
Epsilon Delta wrote:
Mon Dec 17, 2018 4:26 pm
Although liquidity is important there is a point of diminishing returns. Once the basis in our Roths was larger than the mortgage I felt I had gone well past that point and could decide to pay off or invest based by comparing the mortgage and bond rates.

Carrying excess liquidity is insuring against very rare events. There are usually other, more common, events where the insurance premium could be better spent. Aiming for higher returns, and hence a higher net worth is in some measure buying insurance against everything.
Epsilon Delta,

<<Carrying excess liquidity is insuring against very rare events. >>

There are 2 dimensions to risk: probability and severity. Just because it is rare, it is not a sufficient reason not to insure against that risk if the severity is high enough.

KlangFool
Rarity is not sufficient reason to forgo insurance but cost is. There are infinitely many very severe but very rare events you could try to insure against. You cannot afford to insure all of them. Liquidity costs and at some point there are better things to spend that money on.

NextMil
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Re: Pre-paying mortgage only in early years

Post by NextMil » Mon Dec 17, 2018 5:39 pm

KlangFool wrote:
Mon Dec 17, 2018 4:44 pm
Epsilon Delta wrote:
Mon Dec 17, 2018 4:26 pm
Although liquidity is important there is a point of diminishing returns. Once the basis in our Roths was larger than the mortgage I felt I had gone well past that point and could decide to pay off or invest based by comparing the mortgage and bond rates.

Carrying excess liquidity is insuring against very rare events. There are usually other, more common, events where the insurance premium could be better spent. Aiming for higher returns, and hence a higher net worth is in some measure buying insurance against everything.
Epsilon Delta,

<<Carrying excess liquidity is insuring against very rare events. >>

There are 2 dimensions to risk: probability and severity. Just because it is rare, it is not a sufficient reason not to insure against that risk if the severity is high enough.

KlangFool
Your risk meter is broken because you see it very myopically.

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