Admiral wrote: ↑
Tue Sep 03, 2019 1:02 pm
aristotelian wrote: ↑
Tue Sep 03, 2019 8:31 am
Bonds are earning about 2% right now. If you are choosing between paying down mortgage and buying bonds, you should certainly be paying down the mortgage at 3.875%.
So one should make their mortgage-paydown decision based on the daily fluctuations in the bond market? That's what you're suggesting? YTD TBM is up way more than 2%. Perhaps you're looking at LT treasuries?
I don't think what bonds are yielding TODAY should be relevant to a pay down decision. Bonds can sold. Home equity can't. Bonds also produce income that is/can be reinvested at prevailing rates.
What bonds are yielding today, and the mortgage rate, are exactly what are relevant. If you have 15 years left on your mortgage, you could buy a portfolio of bonds maturing in 1-15 years, paying enough each year to make that year's mortgage payments. If you do this, and use the bond payments to make the mortgage payments, you won't have any bond income to reinvest; you will be in the same position as if you had neither the bond portfolio nor the mortgage. The benefit of selling this bond portfolio to pay off your mortgage is the difference between bond prices and the mortgage principal. Bond prices depend on the current yields of the bonds. If bond yields are equal to mortgage rates, you break even by holding the bond portfolio. If bond yields are lower than mortgage rates, you gain by selling these bonds to pay off the mortgage; selling $210K of bonds to avoid making payments on a $200K mortgage is a 5% net gain. (If you hold a different bond portfolio, you are making a trade-off between return and risk; the liability matching portfolio is a fair comparison.)
Now, this doesn't mean that you should necessarily sell your bonds to pay off your mortgage just because the mortgage rates are higher. You get a benefit which depends on the difference, but you must weigh that benefit against the costs. If you pay off your mortgage, you lose liquidity, as it is harder to get money out of the house than to sell your bonds. If rates fall, you lose the opportunity to refinance the mortgage. If rates rise, you may be better off keeping the bonds at that point, but you will lose the benefit if you have already sold them.
The comparison to stock returns is only appropriate if you have 100% stock. If you hold any bonds, you can get higher expected returns with more risk by selling those bonds to buy stock. But if you don't want to take that risk, then you have the option of selling the bonds to pay down your mortgage, and whether that is a good deal is independent of what the stock market does.
For the OP, the proper mortgage rate to use for comparison is probably not the current rate, but the 3.25% that he could get by refinancing to a 15-year mortgage; since he is already paying off the mortgage at a 15-year rate and has no liquidity issues, it is worth refinancing rather than keeping the old mortgage. A 15-year mortgage has a 7-year duration, so the bond fund to use for comparison is Admiral shares of Vanguard Long-Term Tax-Exempt, yielding 1.86%.
So this is a net gain of 1.39% annualized for paying off the mortgage if the interest is not deductible, or 0.61% if it is all deductible at a 24% rate (which would require a married couple to be contributing $14,400 to charity). With no need for liquidity, I would take the 1.39% gain easily, and probably even the 0.61%.