Paying off mortgage early - am I thinking about this right?

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Variant
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Paying off mortgage early - am I thinking about this right?

Post by Variant » Tue Sep 03, 2019 1:25 am

Trying to crunch the numbers on whether or not it makes sense to pay off my mortgage.

Am currently seven years in to a 30-year fixed @ 3.875% w/ original principal at $334,900. Monthly payment is about $1,500 (this includes interest) to which I've been adding an additional $500 towards the principal since payment #56. I also made another one-time $8,000 principal payment which gets my current remaining loan balance to about $260K.

At my current payment rate, I'll have the loan paid off in about 15 years.

Assuming a conservative 4% interest rate (muni bond rate seems to be what's referenced in the wiki page on all of this), over the same period that $260K could become $468K, assuming no additional contributions.

If, instead, I use the $260K to pay off my mortgage and immediately start investing the ~$2,000/mo formerly used for my mortgage payment, also at 4%, it looks like I'd end up with about $480K over the same 15 years.

However, if I bump the interest rate to 5%, I suddenly end up about $23K ahead over 15 years by continuing with my $2k/mo mortgage payments. The advantage for holding widens from there.

Am I thinking about this in the right way? Trying to be as apples to apples as possible.

Notes:
  • I'm already maxing out my 401K, working on getting Backdoor Roth going, etc.
  • I have no other debt
  • Even if I paid off the house, I could generate an additional $250K of liquidity short notice from taxable brokerage account while I rebuilt my emergency fund
  • I used Excel's FV() function for my investment return calculations

mhalley
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Re: Paying off mortgage early - am I thinking about this right?

Post by mhalley » Tue Sep 03, 2019 1:58 am

The financially correct thing to do is not pay off the mortgage. But this is personal finance, and being debt free is a hugely satisfying position to be in. As long as you are maxing retirement plus Roth, paying extra on the mortgage is fine. But it doesn’t have to be all or none, you can always put half to mortgage and half to taxable savings. Another option is to refinance to a 15 yr mortgage if you can afford it and get a lower rate.

international001
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Re: Paying off mortgage early - am I thinking about this right?

Post by international001 » Tue Sep 03, 2019 5:38 am

My take is that it depends. And many others have different opinions
Paying off the mortgage is like investing on a bond.
3.875% w/o taxes is an excellent rate in today's market. Let's assume you have 0% of defaulting.

If you have enough stocks in your portfolio, balance it with this 'bond'. If you are very young and you want 0% bonds in your portfolio, perhaps it's better to invest the money in stocks.

grettman
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Re: Paying off mortgage early - am I thinking about this right?

Post by grettman » Tue Sep 03, 2019 5:42 am

What if the market goes down 4%? What if it stays down for several years? I remember a time when the market wasn’t going up, up, up and people waited for it to get better...

student
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Re: Paying off mortgage early - am I thinking about this right?

Post by student » Tue Sep 03, 2019 6:15 am

I think it depends on the performance of the stock market. Both plans (continue on current setup and pay off the mortgage now) are reasonable. However, I would suggest not choosing the second option if you have to pay capital gain on selling investments in your taxable accounts.

Grt2bOutdoors
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Re: Paying off mortgage early - am I thinking about this right?

Post by Grt2bOutdoors » Tue Sep 03, 2019 6:16 am

How secure is your employment? Muni bonds are not paying 4% taxable equivalent yields, they are lower than that now. If you pay off your mortgage today, you will exchange a liquid asset for an illiquid one that has high transaction costs to access (sale or borrow against).
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

cherijoh
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Re: Paying off mortgage early - am I thinking about this right?

Post by cherijoh » Tue Sep 03, 2019 6:38 am

Variant wrote:
Tue Sep 03, 2019 1:25 am
Trying to crunch the numbers on whether or not it makes sense to pay off my mortgage.

Am currently seven years in to a 30-year fixed @ 3.875% w/ original principal at $334,900. Monthly payment is about $1,500 (this includes interest) to which I've been adding an additional $500 towards the principal since payment #56. I also made another one-time $8,000 principal payment which gets my current remaining loan balance to about $260K.

At my current payment rate, I'll have the loan paid off in about 15 years.

...

Am I thinking about this in the right way? Trying to be as apples to apples as possible.

Notes:
  • I'm already maxing out my 401K, working on getting Backdoor Roth going, etc.
  • I have no other debt
  • Even if I paid off the house, I could generate an additional $250K of liquidity short notice from taxable brokerage account while I rebuilt my emergency fund
  • I used Excel's FV() function for my investment return calculations
Where would you get the $260k to pay off the mortgage? Are there costs associated with doing so (e.g., capital gains tax)?

IMO, the calculations you are doing can never give you the full picture, because you don't have a clue about future interest rates. So holding on to
low-interest-rate mortgage could look brilliant in hindsight if interest rates spike like they did in the late 70s early 80s. (My parents held a 4.75% VA loan while earning double digit returns on a CD that could have paid off the mortgage balance). Therefore, I'd base my decision on more than a simple point-in-time analysis.

How much of your net worth is currently tied up in home equity? What would the picture look like after you pay of the mortgage?

Personally, I wouldn't feel comfortable tying up too much of my net worth in my home. I purchased my house in a higher interest rate environment, so I started with a 30-yr mortgage @ 7.75%. I subsequently refinanced to a 15-yr mortgage @ 6.25% and then a 10-yr mortgage at 5.25%. I didn't pay any extra on principal until I was very close to payoff, but still managed to pay the mortgage off in ~21 years. By that time, my house represented < 15% of my net worth.

To those who say "the peace of mind from being debt free is priceless", I will counter with the fact that knowing you could easily pay off the mortgage at any can give you the same peace of mind and gives you a lot more flexibility.

Bacchus01
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Re: Paying off mortgage early - am I thinking about this right?

Post by Bacchus01 » Tue Sep 03, 2019 6:59 am

grettman wrote:
Tue Sep 03, 2019 5:42 am
What if the market goes down 4%? What if it stays down for several years? I remember a time when the market wasn’t going up, up, up and people waited for it to get better...
The mortgage timeframe is 23 years. Can you name all the periods stock returns over 23 years that we’re negative? Any of them?

SandysDad
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Re: Paying off mortgage early - am I thinking about this right?

Post by SandysDad » Tue Sep 03, 2019 7:08 am

I think your equivalent bond interest rate of 4% is way too high.

As long as you have liquidity after paying it off (which you say you do), think of it as follows:
- what is your target asset allocation now and say 7 years from now
- how much do you current have in bonds for that AA?
- if you subtract your mortgage from the above amount in bonds how close are you to your target AA?

If you answer the 3rd question and you are way short on your target bond allocation consider paying it off.
Again only do this if your are confident of your liquidity after paying it off. Oh, and if you have large capital gains to pay it off also reconsider.

MikeG62
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Re: Paying off mortgage early - am I thinking about this right?

Post by MikeG62 » Tue Sep 03, 2019 7:09 am

Variant wrote:
Tue Sep 03, 2019 1:25 am
Trying to crunch the numbers on whether or not it makes sense to pay off my mortgage.

Am currently seven years in to a 30-year fixed @ 3.875% w/ original principal at $334,900. Monthly payment is about $1,500 (this includes interest) to which I've been adding an additional $500 towards the principal since payment #56. I also made another one-time $8,000 principal payment which gets my current remaining loan balance to about $260K.

At my current payment rate, I'll have the loan paid off in about 15 years.

Assuming a conservative 4% interest rate (muni bond rate seems to be what's referenced in the wiki page on all of this), over the same period that $260K could become $468K, assuming no additional contributions.

If, instead, I use the $260K to pay off my mortgage and immediately start investing the ~$2,000/mo formerly used for my mortgage payment, also at 4%, it looks like I'd end up with about $480K over the same 15 years.
I would say it depends.

1. Where/how is the $260K invested now?
2. How much is the $260K of your taxable financial assets?
3. Do you itemize deductions (i.e., is the interest tax deductible to you)?
4. Do you plan to move in the future or are you going to stay put?

A guaranteed 3.875% return would certainly be enticing to me. However, I'd want to know the answers to the questions above.
Real Knowledge Comes Only From Experience

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Watty
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Re: Paying off mortgage early - am I thinking about this right?

Post by Watty » Tue Sep 03, 2019 7:15 am

...am I thinking about this right?
You are missing the sequence of returns risk. This is a very simplistic example that I have posted before.
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
You can make a much more complex model but however you crunch the numbers there is a significant sequence of returns risk that could cause you problems.

There have also been lots of threads about "mortage as a negative" bond that you can look up. That is not exact but using the mortage for leverage does increase your overall risk.

If you will be retiring before the mortage is paid off that would also be a consideration to factor into your plans.

petulant
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Re: Paying off mortgage early - am I thinking about this right?

Post by petulant » Tue Sep 03, 2019 7:18 am

Another wrinkle is that, even if you could hold the mortgage and buy other assets to earn a return, there is more risk to your cash flow. The mortgage is being financed by your future cash flows, so if you lose your job, you may have to liquidate the assets at just the time they're tanking (for the same reason you lost your job). With your house paid off, monthly expenses would be less risky.

stan1
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Re: Paying off mortgage early - am I thinking about this right?

Post by stan1 » Tue Sep 03, 2019 7:23 am

Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.

petulant
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Re: Paying off mortgage early - am I thinking about this right?

Post by petulant » Tue Sep 03, 2019 7:38 am

stan1 wrote:
Tue Sep 03, 2019 7:23 am
Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.
The problem is, a liquidity event may be correlated with a recession or other event that reduces asset values outside the house.

People making your point also often overlook the availability of home equity lines of credit. The interest rates are likely less favorable than mortgages, but they compare well to other kinds of debt. Getting $10-20K out of HELOC may be preferable to selling stocks in a downturn.

Valuethinker
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Re: Paying off mortgage early - am I thinking about this right?

Post by Valuethinker » Tue Sep 03, 2019 7:43 am

Variant wrote:
Tue Sep 03, 2019 1:25 am
Trying to crunch the numbers on whether or not it makes sense to pay off my mortgage.

Am currently seven years in to a 30-year fixed @ 3.875% w/ original principal at $334,900. Monthly payment is about $1,500 (this includes interest) to which I've been adding an additional $500 towards the principal since payment #56. I also made another one-time $8,000 principal payment which gets my current remaining loan balance to about $260K.

At my current payment rate, I'll have the loan paid off in about 15 years.

Assuming a conservative 4% interest rate (muni bond rate seems to be what's referenced in the wiki page on all of this), over the same period that $260K could become $468K, assuming no additional contributions.

If, instead, I use the $260K to pay off my mortgage and immediately start investing the ~$2,000/mo formerly used for my mortgage payment, also at 4%, it looks like I'd end up with about $480K over the same 15 years.

However, if I bump the interest rate to 5%, I suddenly end up about $23K ahead over 15 years by continuing with my $2k/mo mortgage payments. The advantage for holding widens from there.

Am I thinking about this in the right way? Trying to be as apples to apples as possible.

Notes:
  • I'm already maxing out my 401K, working on getting Backdoor Roth going, etc.
  • I have no other debt
  • Even if I paid off the house, I could generate an additional $250K of liquidity short notice from taxable brokerage account while I rebuilt my emergency fund
  • I used Excel's FV() function for my investment return calculations
The risk free return on this after tax is 3.875%.

There's no equivalent after tax risk free that I know of, right now. US Treasury bonds pay 2.0%? Stocks might give you 5-8% pa but the volatility is huge.

So it's a good return investment - risk free.

However it does reduce your liquidity. This is likely the cheapest money you will ever borrow.

When you don't know with major financial decisions, then the best solution is often to "split the difference". Go half way.

stan1
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Re: Paying off mortgage early - am I thinking about this right?

Post by stan1 » Tue Sep 03, 2019 7:47 am

petulant wrote:
Tue Sep 03, 2019 7:38 am
stan1 wrote:
Tue Sep 03, 2019 7:23 am
Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.
The problem is, a liquidity event may be correlated with a recession or other event that reduces asset values outside the house.

People making your point also often overlook the availability of home equity lines of credit. The interest rates are likely less favorable than mortgages, but they compare well to other kinds of debt. Getting $10-20K out of HELOC may be preferable to selling stocks in a downturn.
Actually back in 2008-2010 banks closed or reduced home equity lines of credit even for people who had good incomes and did not lose their jobs. You can't rely on a HELOC being there when you really need it.

Also if someone is laid off and needs to move to a new location to find a new job a paid off home does not help. Someone many years away from retirement should leverage their intellectual capital to build wealth and that might have to be in a different location.

As I said it is mostly a personal decision. Either a larger taxable account or a paid off home is better than a large mortgage and no investments. Doing some of both (taxable investing and accelerating mortgage paydown) is a common approach.

EnjoyIt
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Re: Paying off mortgage early - am I thinking about this right?

Post by EnjoyIt » Tue Sep 03, 2019 8:18 am

Watty wrote:
Tue Sep 03, 2019 7:15 am
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
I keep seeing this thing above pop up and it is WRONG WRONG WRONG. The above assumes one will keep the $100k and pay off the mortgage from the earnings and not use up principal. This is not what any of the pay off mortgage threads talk about. I really wish people would stop posting this nonsense.

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Watty
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Re: Paying off mortgage early - am I thinking about this right?

Post by Watty » Tue Sep 03, 2019 8:29 am

EnjoyIt wrote:
Tue Sep 03, 2019 8:18 am
Watty wrote:
Tue Sep 03, 2019 7:15 am
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
I keep seeing this thing above pop up and it is WRONG WRONG WRONG. The above assumes one will keep the $100k and pay off the mortgage from the earnings and not use up principal. This is not what any of the pay off mortgage threads talk about. I really wish people would stop posting this nonsense.
Could you give an example with some numbers to show how it is wrong?

If you have a mortage the money to make the monthly payment needs to come from somewhere. If you just pay it out of your paycheck then in this example that would be $500 a month that you would not be able depositing into your savings.

aristotelian
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Re: Paying off mortgage early - am I thinking about this right?

Post by aristotelian » 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%.

EnjoyIt
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Re: Paying off mortgage early - am I thinking about this right?

Post by EnjoyIt » Tue Sep 03, 2019 8:51 am

Watty wrote:
Tue Sep 03, 2019 8:29 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:18 am
Watty wrote:
Tue Sep 03, 2019 7:15 am
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
I keep seeing this thing above pop up and it is WRONG WRONG WRONG. The above assumes one will keep the $100k and pay off the mortgage from the earnings and not use up principal. This is not what any of the pay off mortgage threads talk about. I really wish people would stop posting this nonsense.
Could you give an example with some numbers to show how it is wrong?

If you have a mortage the money to make the monthly payment needs to come from somewhere. If you just pay it out of your paycheck then in this example that would be $500 a month that you would not be able depositing into your savings.
You are assuming the $100k has to stay at $100k at the end of the loan payment. This is not what is happening. The $100k is meant to go down to $0 or slightly above it in an ideal situation.

An example is a person has $100k loan at 3% over 30 years. Payments are $421.60 a month. If for this example the person has an account holding $100k which is invested in a 3% tax-free fund (I know it doesn't exist, just an example,) by the end of the 30 year term the fund will be worth $0 and the loan will be paid off. This is where you start your argument. If returns are lower than 3% over 30 years then this was a bad decision. If returns are higher than 3% over 30 years then this was a good decision. This person would not expect to still have the $100k left over as your example suggests.

I am pretty sure you and I have gone through this at least once before yet you still keep posting your example. Now if you really want to figure out sequence of return risk then instead of creating a straw man example, plug it into fircalc and see what comes up and what is the risk of running out of money before the 30 years is up. News flash in my hypothetical example the historical chance of coming back with less than started is 0%

EDIT: The results from FIRECalc on my hypothetical example is:
Here is how your portfolio would have fared in each of the 119 cycles. The lowest and highest portfolio balance at the end of your retirement was $100,000 to $905,355, with an average at the end of $478,683.

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Re: Paying off mortgage early - am I thinking about this right?

Post by Dottie57 » Tue Sep 03, 2019 9:12 am

mhalley wrote:
Tue Sep 03, 2019 1:58 am
The financially correct thing to do is not pay off the mortgage. But this is personal finance, and being debt free is a hugely satisfying position to be in. As long as you are maxing retirement plus Roth, paying extra on the mortgage is fine. But it doesn’t have to be all or none, you can always put half to mortgage and half to taxable savings. Another option is to refinance to a 15 yr mortgage if you can afford it and get a lower rate.
This. Try to never have “all or nothing” thinking.

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9-5 Suited
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Re: Paying off mortgage early - am I thinking about this right?

Post by 9-5 Suited » Tue Sep 03, 2019 9:12 am

Choosing between mortgage paydown vs. bond investing = decision about value of liquidity and mortgage optionality vs. lower returns for same risk (at current rates).

Choosing between mortgage paydown vs. stock investing = fundamental decision about asset allocation and risk tolerance.

Since you have a highly liquid position and seem to have a desire to be debt free, I would pay down the mortgage in lieu of investing in bonds (which don't pay as much as you're stating and definitely less than your mortgage rate). If you want to soul search on your risk tolerance and desire to use your mortgage as leverage for a larger portfolio of stocks, then that's a separate thing that only you can really answer.

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Re: Paying off mortgage early - am I thinking about this right?

Post by 9-5 Suited » Tue Sep 03, 2019 9:24 am

mhalley wrote:
Tue Sep 03, 2019 1:58 am
The financially correct thing to do is not pay off the mortgage. But this is personal finance, and being debt free is a hugely satisfying position to be in. As long as you are maxing retirement plus Roth, paying extra on the mortgage is fine. But it doesn’t have to be all or none, you can always put half to mortgage and half to taxable savings. Another option is to refinance to a 15 yr mortgage if you can afford it and get a lower rate.
This is a good sentiment. One quibble with the first sentence. The best way to maximize expected return is to not pay off the mortgage. That's very different from "the financially correct thing to do" which may or may not be to pay off the mortgage depending on many circumstances. I just think the terminology chosen there is too broad and makes the statement less accurate.

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Re: Paying off mortgage early - am I thinking about this right?

Post by willthrill81 » Tue Sep 03, 2019 11:37 am

EnjoyIt wrote:
Tue Sep 03, 2019 8:51 am
Watty wrote:
Tue Sep 03, 2019 8:29 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:18 am
Watty wrote:
Tue Sep 03, 2019 7:15 am
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
I keep seeing this thing above pop up and it is WRONG WRONG WRONG. The above assumes one will keep the $100k and pay off the mortgage from the earnings and not use up principal. This is not what any of the pay off mortgage threads talk about. I really wish people would stop posting this nonsense.
Could you give an example with some numbers to show how it is wrong?

If you have a mortage the money to make the monthly payment needs to come from somewhere. If you just pay it out of your paycheck then in this example that would be $500 a month that you would not be able depositing into your savings.
You are assuming the $100k has to stay at $100k at the end of the loan payment. This is not what is happening. The $100k is meant to go down to $0 or slightly above it in an ideal situation.

An example is a person has $100k loan at 3% over 30 years. Payments are $421.60 a month. If for this example the person has an account holding $100k which is invested in a 3% tax-free fund (I know it doesn't exist, just an example,) by the end of the 30 year term the fund will be worth $0 and the loan will be paid off. This is where you start your argument. If returns are lower than 3% over 30 years then this was a bad decision. If returns are higher than 3% over 30 years then this was a good decision. This person would not expect to still have the $100k left over as your example suggests.
The point remains that if the mortgage is being paid for from the portfolio, then sequence of returns risk is present. Average returns over the next 30 years are not applicable unless the mortgage can be paid using non-portfolio funds. Using your example of a $100k loan and a $421.60 payment, that's equivalent to a 5.06% fixed withdrawal rate. According to FIRECalc, a 100% stock portfolio would only have supported that for 30 years 73.9% of the time. Yes, that rate could have been improved historically with an allocation to bonds, but that wouldn't be beneficial now because bond yields are significantly lower than the OP's mortgage rate.

Leverage, be it a mortgage or any other form of debt, might help you or it might hurt you.
“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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Nate79
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Re: Paying off mortgage early - am I thinking about this right?

Post by Nate79 » Tue Sep 03, 2019 11:40 am

If you have held bonds in your portfolio and held a mortgage historically this has been the wrong decision - you have been losing between the interest rate spread on a comparable tax basis. If you want to borrow money and hold 100% in stocks that's different.

FIREmeup
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Re: Paying off mortgage early - am I thinking about this right?

Post by FIREmeup » Tue Sep 03, 2019 11:58 am

You sound like me. $350k mortage at 3.875% than began in early 2012. I decided to place my bond allocation stated in my IPS into my mortgage. Over the years it has equaled about 1500 to 2000 a month extra on average. Unquestionably in retrospect I should have just put it all in the market. But, personally, I am happy, if things continue as is, in January 2021 I will make my final payment and my expenses will drop a nice chunk and I will then begin investing in bonds for real. The 3.875% guaranteed return has been great. Yeah blah blah blah its pre tax. You have to choose if you want the sure thing or gamble on better rates in the market.

Good luck.

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Re: Paying off mortgage early - am I thinking about this right?

Post by nolesrule » Tue Sep 03, 2019 12:03 pm

Refinance into a lower rate.

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Re: Paying off mortgage early - am I thinking about this right?

Post by whodidntante » Tue Sep 03, 2019 12:17 pm

We are going to figure out the correct answer to this question someday, I just know it. :happy

I've recently started prepaying my mortgage from cash flow. I am paying it off from cash flow because didn't want to pay capital gains tax. I'm doing it because in the current environment it did not make sense FOR ME to be both long and short fixed income.

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Re: Paying off mortgage early - am I thinking about this right?

Post by willthrill81 » Tue Sep 03, 2019 12:22 pm

whodidntante wrote:
Tue Sep 03, 2019 12:17 pm
We are going to figure out the correct answer to this question someday, I just know it. :happy
Probably the day after we figure out what the ideal AA is.
“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: Paying off mortgage early - am I thinking about this right?

Post by jnightingale73 » Tue Sep 03, 2019 12:57 pm

stan1 wrote:
Tue Sep 03, 2019 7:47 am
petulant wrote:
Tue Sep 03, 2019 7:38 am
stan1 wrote:
Tue Sep 03, 2019 7:23 am
Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.
The problem is, a liquidity event may be correlated with a recession or other event that reduces asset values outside the house.

People making your point also often overlook the availability of home equity lines of credit. The interest rates are likely less favorable than mortgages, but they compare well to other kinds of debt. Getting $10-20K out of HELOC may be preferable to selling stocks in a downturn.
Actually back in 2008-2010 banks closed or reduced home equity lines of credit even for people who had good incomes and did not lose their jobs. You can't rely on a HELOC being there when you really need it.

Also if someone is laid off and needs to move to a new location to find a new job a paid off home does not help. Someone many years away from retirement should leverage their intellectual capital to build wealth and that might have to be in a different location.

As I said it is mostly a personal decision. Either a larger taxable account or a paid off home is better than a large mortgage and no investments. Doing some of both (taxable investing and accelerating mortgage paydown) is a common approach.
I can vouch for the bolded, as it happened to me. HELOCs are no guarantee down the road.

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Re: Paying off mortgage early - am I thinking about this right?

Post by Admiral » 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.

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Re: Paying off mortgage early - am I thinking about this right?

Post by aristotelian » Tue Sep 03, 2019 1:20 pm

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.
Sure. It is a simple arbitrage decision. If bond yields go back up, then you start buying bonds again.

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Re: Paying off mortgage early - am I thinking about this right?

Post by Watty » Tue Sep 03, 2019 3:00 pm

EnjoyIt wrote:
Tue Sep 03, 2019 8:51 am
Watty wrote:
Tue Sep 03, 2019 8:29 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:18 am
Watty wrote:
Tue Sep 03, 2019 7:15 am
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.
I keep seeing this thing above pop up and it is WRONG WRONG WRONG. The above assumes one will keep the $100k and pay off the mortgage from the earnings and not use up principal. This is not what any of the pay off mortgage threads talk about. I really wish people would stop posting this nonsense.
Could you give an example with some numbers to show how it is wrong?

If you have a mortage the money to make the monthly payment needs to come from somewhere. If you just pay it out of your paycheck then in this example that would be $500 a month that you would not be able depositing into your savings.
You are assuming the $100k has to stay at $100k at the end of the loan payment. This is not what is happening. The $100k is meant to go down to $0 or slightly above it in an ideal situation.

An example is a person has $100k loan at 3% over 30 years. Payments are $421.60 a month. If for this example the person has an account holding $100k which is invested in a 3% tax-free fund (I know it doesn't exist, just an example,) by the end of the 30 year term the fund will be worth $0 and the loan will be paid off. This is where you start your argument. If returns are lower than 3% over 30 years then this was a bad decision. If returns are higher than 3% over 30 years then this was a good decision. This person would not expect to still have the $100k left over as your example suggests.

I am pretty sure you and I have gone through this at least once before yet you still keep posting your example. Now if you really want to figure out sequence of return risk then instead of creating a straw man example, plug it into fircalc and see what comes up and what is the risk of running out of money before the 30 years is up. News flash in my hypothetical example the historical chance of coming back with less than started is 0%

EDIT: The results from FIRECalc on my hypothetical example is:
Here is how your portfolio would have fared in each of the 119 cycles. The lowest and highest portfolio balance at the end of your retirement was $100,000 to $905,355, with an average at the end of $478,683.
I can remember that prior discussion but I can't find it.

I didn't want to hijack this thread so I started this new thread to discuss my example.

viewtopic.php?f=10&t=289677

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Re: Paying off mortgage early - am I thinking about this right?

Post by petulant » Tue Sep 03, 2019 5:45 pm

stan1 wrote:
Tue Sep 03, 2019 7:47 am
Actually back in 2008-2010 banks closed or reduced home equity lines of credit even for people who had good incomes and did not lose their jobs. You can't rely on a HELOC being there when you really need it.

Also if someone is laid off and needs to move to a new location to find a new job a paid off home does not help. Someone many years away from retirement should leverage their intellectual capital to build wealth and that might have to be in a different location.

As I said it is mostly a personal decision. Either a larger taxable account or a paid off home is better than a large mortgage and no investments. Doing some of both (taxable investing and accelerating mortgage paydown) is a common approach.
jnightingale73 wrote:
Tue Sep 03, 2019 12:57 pm
I can vouch for the bolded, as it happened to me. HELOCs are no guarantee down the road.
Yes, I was aware some HELOCs got closed. My original point was not that HELOCs were completely and fully reliable--only that many people who claim houses have no liquidity never seem to mention HELOCs (or the ability to take out a new mortgage). It's a bit of a goal post move to go from not mentioned at all to them not being completely reliable. ;-)

Also, I wonder about these examples since it was common practice during the 2008 run-up for people to add HELOCs on top of existing mortgages. Obviously if the HELOC was supported by new equity from appreciation but was subordinate to a mortgage's first lien, banks were wise to cut the HELOCs when the new equity was in doubt. So in any of the examples where HELOCs got cut or cancelled, was the HELOC the only home loan since the owner paid off the mortgage? My intuition is that these would be much more reliable arrangements.

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Re: Paying off mortgage early - am I thinking about this right?

Post by grabiner » Tue Sep 03, 2019 8:50 pm

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%.
Wiki David Grabiner

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Re: Paying off mortgage early - am I thinking about this right?

Post by EnjoyIt » Tue Sep 03, 2019 10:08 pm

willthrill81 wrote:
Tue Sep 03, 2019 11:37 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:51 am
Watty wrote:
Tue Sep 03, 2019 8:29 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:18 am
Watty wrote:
Tue Sep 03, 2019 7:15 am


I keep seeing this thing above pop up and it is WRONG WRONG WRONG. The above assumes one will keep the $100k and pay off the mortgage from the earnings and not use up principal. This is not what any of the pay off mortgage threads talk about. I really wish people would stop posting this nonsense.
Could you give an example with some numbers to show how it is wrong?

If you have a mortage the money to make the monthly payment needs to come from somewhere. If you just pay it out of your paycheck then in this example that would be $500 a month that you would not be able depositing into your savings.
You are assuming the $100k has to stay at $100k at the end of the loan payment. This is not what is happening. The $100k is meant to go down to $0 or slightly above it in an ideal situation.

An example is a person has $100k loan at 3% over 30 years. Payments are $421.60 a month. If for this example the person has an account holding $100k which is invested in a 3% tax-free fund (I know it doesn't exist, just an example,) by the end of the 30 year term the fund will be worth $0 and the loan will be paid off. This is where you start your argument. If returns are lower than 3% over 30 years then this was a bad decision. If returns are higher than 3% over 30 years then this was a good decision. This person would not expect to still have the $100k left over as your example suggests.
The point remains that if the mortgage is being paid for from the portfolio, then sequence of returns risk is present. Average returns over the next 30 years are not applicable unless the mortgage can be paid using non-portfolio funds. Using your example of a $100k loan and a $421.60 payment, that's equivalent to a 5.06% fixed withdrawal rate. According to FIRECalc, a 100% stock portfolio would only have supported that for 30 years 73.9% of the time. Yes, that rate could have been improved historically with an allocation to bonds, but that wouldn't be beneficial now because bond yields are significantly lower than the OP's mortgage rate.

Leverage, be it a mortgage or any other form of debt, might help you or it might hurt you.
I made a mistake in my FIRECalc. I used a payment of 421.60 a year instead of a month which is why I got such great results. Your correction is also inaccurate since you use inflation adjusted spending. But the 421.60 does not increase with inflation as you calculated. At the end of the day, Watty's example is not what people do.

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Re: Paying off mortgage early - am I thinking about this right?

Post by willthrill81 » Tue Sep 03, 2019 11:03 pm

EnjoyIt wrote:
Tue Sep 03, 2019 10:08 pm
willthrill81 wrote:
Tue Sep 03, 2019 11:37 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:51 am
Watty wrote:
Tue Sep 03, 2019 8:29 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:18 am


I keep seeing this thing above pop up and it is WRONG WRONG WRONG. The above assumes one will keep the $100k and pay off the mortgage from the earnings and not use up principal. This is not what any of the pay off mortgage threads talk about. I really wish people would stop posting this nonsense.
Could you give an example with some numbers to show how it is wrong?

If you have a mortage the money to make the monthly payment needs to come from somewhere. If you just pay it out of your paycheck then in this example that would be $500 a month that you would not be able depositing into your savings.
You are assuming the $100k has to stay at $100k at the end of the loan payment. This is not what is happening. The $100k is meant to go down to $0 or slightly above it in an ideal situation.

An example is a person has $100k loan at 3% over 30 years. Payments are $421.60 a month. If for this example the person has an account holding $100k which is invested in a 3% tax-free fund (I know it doesn't exist, just an example,) by the end of the 30 year term the fund will be worth $0 and the loan will be paid off. This is where you start your argument. If returns are lower than 3% over 30 years then this was a bad decision. If returns are higher than 3% over 30 years then this was a good decision. This person would not expect to still have the $100k left over as your example suggests.
The point remains that if the mortgage is being paid for from the portfolio, then sequence of returns risk is present. Average returns over the next 30 years are not applicable unless the mortgage can be paid using non-portfolio funds. Using your example of a $100k loan and a $421.60 payment, that's equivalent to a 5.06% fixed withdrawal rate. According to FIRECalc, a 100% stock portfolio would only have supported that for 30 years 73.9% of the time. Yes, that rate could have been improved historically with an allocation to bonds, but that wouldn't be beneficial now because bond yields are significantly lower than the OP's mortgage rate.

Leverage, be it a mortgage or any other form of debt, might help you or it might hurt you.
I made a mistake in my FIRECalc. I used a payment of 421.60 a year instead of a month which is why I got such great results. Your correction is also inaccurate since you use inflation adjusted spending. But the 421.60 does not increase with inflation as you calculated. At the end of the day, Watty's example is not what people do.
Yes, I noticed that I mistakenly accounted for inflation earlier. In other analyses (see the other active) that do not include inflation, however, they still indicate that paying for a mortgage from portfolio withdrawals carries significant sequence of returns risk.
“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: Paying off mortgage early - am I thinking about this right?

Post by EnjoyIt » Tue Sep 03, 2019 11:18 pm

willthrill81 wrote:
Tue Sep 03, 2019 11:03 pm
EnjoyIt wrote:
Tue Sep 03, 2019 10:08 pm
willthrill81 wrote:
Tue Sep 03, 2019 11:37 am
EnjoyIt wrote:
Tue Sep 03, 2019 8:51 am
Watty wrote:
Tue Sep 03, 2019 8:29 am


Could you give an example with some numbers to show how it is wrong?

If you have a mortage the money to make the monthly payment needs to come from somewhere. If you just pay it out of your paycheck then in this example that would be $500 a month that you would not be able depositing into your savings.
You are assuming the $100k has to stay at $100k at the end of the loan payment. This is not what is happening. The $100k is meant to go down to $0 or slightly above it in an ideal situation.

An example is a person has $100k loan at 3% over 30 years. Payments are $421.60 a month. If for this example the person has an account holding $100k which is invested in a 3% tax-free fund (I know it doesn't exist, just an example,) by the end of the 30 year term the fund will be worth $0 and the loan will be paid off. This is where you start your argument. If returns are lower than 3% over 30 years then this was a bad decision. If returns are higher than 3% over 30 years then this was a good decision. This person would not expect to still have the $100k left over as your example suggests.
The point remains that if the mortgage is being paid for from the portfolio, then sequence of returns risk is present. Average returns over the next 30 years are not applicable unless the mortgage can be paid using non-portfolio funds. Using your example of a $100k loan and a $421.60 payment, that's equivalent to a 5.06% fixed withdrawal rate. According to FIRECalc, a 100% stock portfolio would only have supported that for 30 years 73.9% of the time. Yes, that rate could have been improved historically with an allocation to bonds, but that wouldn't be beneficial now because bond yields are significantly lower than the OP's mortgage rate.

Leverage, be it a mortgage or any other form of debt, might help you or it might hurt you.
I made a mistake in my FIRECalc. I used a payment of 421.60 a year instead of a month which is why I got such great results. Your correction is also inaccurate since you use inflation adjusted spending. But the 421.60 does not increase with inflation as you calculated. At the end of the day, Watty's example is not what people do.
Yes, I noticed that I mistakenly accounted for inflation earlier. In other analyses (see the other active) that do not include inflation, however, they still indicate that paying for a mortgage from portfolio withdrawals carries significant sequence of returns risk.
I agree, as we have discussed before, I am a strong proponent of lowering fixed expenses to as low as possible in retirement. That means debt free.

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Re: Paying off mortgage early - am I thinking about this right?

Post by KlangFool » Wed Sep 04, 2019 8:55 am

stan1 wrote:
Tue Sep 03, 2019 7:23 am
Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.
stan1,

A) I have a 300K 3.49% 30 years fixed-rate mortgage.

B) I have 500K in my taxable account.

C) I maxed up my tax-advantaged accounts.

I do not see a reason that I should pay off my 300K mortgage.

KlangFool

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Re: Paying off mortgage early - am I thinking about this right?

Post by EnjoyIt » Wed Sep 04, 2019 9:26 am

KlangFool wrote:
Wed Sep 04, 2019 8:55 am
stan1 wrote:
Tue Sep 03, 2019 7:23 am
Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.
stan1,

A) I have a 300K 3.49% 30 years fixed-rate mortgage.

B) I have 500K in my taxable account.

C) I maxed up my tax-advantaged accounts.

I do not see a reason that I should pay off my 300K mortgage.

KlangFool
I think there are 2 good reasons to pay down a low interest rate mortgage.
1) You are getting close to retirement and want to be debt free in retirement to minimize sequence of return risk.
2) You are so wealthy that the arbitrage between the lower interest rate and the possible expected higher return on your portfolio are not worth your bother.

I think there are 2 common but poor reasons to pay down a low interest rate mortgage.
1) You overbought on the home and very cashflow poor. Getting that debt down and recasting may change your day to day financial outlook. The better answer is to move, but not everyone can or is wiling to do that.
2) It feels good.

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Re: Paying off mortgage early - am I thinking about this right?

Post by willthrill81 » Wed Sep 04, 2019 9:35 am

Valuethinker wrote:
Tue Sep 03, 2019 7:43 am
The risk free return on this after tax is 3.875%.

There's no equivalent after tax risk free that I know of, right now. US Treasury bonds pay 2.0%? Stocks might give you 5-8% pa but the volatility is huge.

So it's a good return investment - risk free.

However it does reduce your liquidity. This is likely the cheapest money you will ever borrow.

When you don't know with major financial decisions, then the best solution is often to "split the difference". Go half way.
I agree that splitting the difference may be the best move for many who aren't entirely convinced by either side of this issue.

As an aside, you actually can borrow money at a lower rate than 3.875% right now via multiple credit cards. You take a cash advance with one existing credit card and immediately transfer that balance to a new credit card with a 15 or 18 month 0% interest promo period. A 3% balance transfer fee plus maybe a day or two's interest on the first card is all that you pay. If the new card doesn't require payments over the promo period, this works out to about a 2% APR. Obviously, you cannot borrow as much with this strategy as you can with a mortgage though.
“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: Paying off mortgage early - am I thinking about this right?

Post by international001 » Wed Sep 04, 2019 10:33 am

EnjoyIt wrote:
Wed Sep 04, 2019 9:26 am
KlangFool wrote:
Wed Sep 04, 2019 8:55 am
stan1 wrote:
Tue Sep 03, 2019 7:23 am
Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.
stan1,

A) I have a 300K 3.49% 30 years fixed-rate mortgage.

B) I have 500K in my taxable account.

C) I maxed up my tax-advantaged accounts.

I do not see a reason that I should pay off my 300K mortgage.

KlangFool
I think there are 2 good reasons to pay down a low interest rate mortgage.
1) You are getting close to retirement and want to be debt free in retirement to minimize sequence of return risk.
2) You are so wealthy that the arbitrage between the lower interest rate and the possible expected higher return on your portfolio are not worth your bother.

I think there are 2 common but poor reasons to pay down a low interest rate mortgage.
1) You overbought on the home and very cashflow poor. Getting that debt down and recasting may change your day to day financial outlook. The better answer is to move, but not everyone can or is wiling to do that.
2) It feels good.
What is low rate? 3.49% is 4.6% (assume you are in 24% tax bracket). Try to get this with any bond
If you have any any bonds or any cash, this is a better option

For simplicity, I'm disregarding liquidity considerations

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Re: Paying off mortgage early - am I thinking about this right?

Post by Admiral » Wed Sep 04, 2019 10:39 am

grabiner wrote:
Tue Sep 03, 2019 8:50 pm
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%.
How do you propose that the average investor who hold bonds (wisely) in a tax-sheltered account sell those bonds and use the proceeds to pay off the mortgage? I realize that you do, but most people don't have hundreds of thousands of dollars sitting in a taxable account, just waiting to pay a mortgage. Their investments are mostly tax sheltered.

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willthrill81
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Re: Paying off mortgage early - am I thinking about this right?

Post by willthrill81 » Wed Sep 04, 2019 10:45 am

Admiral wrote:
Wed Sep 04, 2019 10:39 am
grabiner wrote:
Tue Sep 03, 2019 8:50 pm
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%.
How do you propose that the average investor who hold bonds (wisely) in a tax-sheltered account sell those bonds and use the proceeds to pay off the mortgage?
There are some plausible and efficient options. The simplest is for the investor to simply direct future contributions that would have gone to buy bonds to pay down the mortgage. If the investor has a taxable account and would not encounter significant capital gains from selling, those funds could be used to pay down the mortgage; if stocks were sold to do this, then a corresponding quantity of bonds in the tax-advantaged account(s) could be exchanged for stocks with no tax implications.

Note that it is not necessary to pay off the mortgage entirely. Simply paying it down still takes advantage of the difference in interest rates/yields.
“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

Admiral
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Re: Paying off mortgage early - am I thinking about this right?

Post by Admiral » Wed Sep 04, 2019 10:48 am

willthrill81 wrote:
Wed Sep 04, 2019 10:45 am
Admiral wrote:
Wed Sep 04, 2019 10:39 am
grabiner wrote:
Tue Sep 03, 2019 8:50 pm
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%.
How do you propose that the average investor who hold bonds (wisely) in a tax-sheltered account sell those bonds and use the proceeds to pay off the mortgage?
There are some plausible and efficient options. The simplest is for the investor to simply direct future contributions that would have gone to buy bonds to pay down the mortgage. If the investor has a taxable account and would not encounter significant capital gains from selling, those funds could be used to pay down the mortgage; if stocks were sold to do this, then a corresponding quantity of bonds in the tax-advantaged account(s) could be exchanged for stocks with no tax implications.

Note that it is not necessary to pay off the mortgage entirely. Simply paying it down still takes advantage of the difference in interest rates/yields.
What you propose is a) a pay down not a pay off and b) sacrifices a tax deduction at one's prevailing federal rate for a minuscule interest savings.

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willthrill81
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Re: Paying off mortgage early - am I thinking about this right?

Post by willthrill81 » Wed Sep 04, 2019 11:07 am

Admiral wrote:
Wed Sep 04, 2019 10:48 am
willthrill81 wrote:
Wed Sep 04, 2019 10:45 am
Admiral wrote:
Wed Sep 04, 2019 10:39 am
grabiner wrote:
Tue Sep 03, 2019 8:50 pm
Admiral wrote:
Tue Sep 03, 2019 1:02 pm


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%.
How do you propose that the average investor who hold bonds (wisely) in a tax-sheltered account sell those bonds and use the proceeds to pay off the mortgage?
There are some plausible and efficient options. The simplest is for the investor to simply direct future contributions that would have gone to buy bonds to pay down the mortgage. If the investor has a taxable account and would not encounter significant capital gains from selling, those funds could be used to pay down the mortgage; if stocks were sold to do this, then a corresponding quantity of bonds in the tax-advantaged account(s) could be exchanged for stocks with no tax implications.

Note that it is not necessary to pay off the mortgage entirely. Simply paying it down still takes advantage of the difference in interest rates/yields.
What you propose is a) a pay down not a pay off and b) sacrifices a tax deduction at one's prevailing federal rate for a minuscule interest savings.
There's nothing wrong with paying down and not paying off.

Whether one gets a tax deduction is very specific to the individual. For instance, we haven't been able to deduct mortgage interest for years. And the difference between a mortgage rate and bond yields may not be minuscule.
“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: Paying off mortgage early - am I thinking about this right?

Post by Stormbringer » Wed Sep 04, 2019 11:10 am

mhalley wrote:
Tue Sep 03, 2019 1:58 am
The financially correct thing to do is not pay off the mortgage.
Mathematically, isn't that identical to advising everyone with a paid off house to mortgage it and invest the proceeds in the markets?
"Compound interest is the most powerful force in the universe." - Albert Einstein

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willthrill81
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Re: Paying off mortgage early - am I thinking about this right?

Post by willthrill81 » Wed Sep 04, 2019 11:12 am

Stormbringer wrote:
Wed Sep 04, 2019 11:10 am
mhalley wrote:
Tue Sep 03, 2019 1:58 am
The financially correct thing to do is not pay off the mortgage.
Mathematically, isn't that identical to advising everyone with a paid off house to mortgage it and invest the proceeds in the markets?
Yes, it is. If you're doing so to buy stock, then historically it would have worked out well on average. But there have been times when doing so would have exacerbated a very poor sequence of returns problem (i.e. it made the good times better and the bad times worse).
“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

Admiral
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Joined: Mon Oct 27, 2014 12:35 pm

Re: Paying off mortgage early - am I thinking about this right?

Post by Admiral » Wed Sep 04, 2019 11:17 am

willthrill81 wrote:
Wed Sep 04, 2019 11:07 am
Admiral wrote:
Wed Sep 04, 2019 10:48 am
willthrill81 wrote:
Wed Sep 04, 2019 10:45 am
Admiral wrote:
Wed Sep 04, 2019 10:39 am
grabiner wrote:
Tue Sep 03, 2019 8:50 pm


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%.
How do you propose that the average investor who hold bonds (wisely) in a tax-sheltered account sell those bonds and use the proceeds to pay off the mortgage?
There are some plausible and efficient options. The simplest is for the investor to simply direct future contributions that would have gone to buy bonds to pay down the mortgage. If the investor has a taxable account and would not encounter significant capital gains from selling, those funds could be used to pay down the mortgage; if stocks were sold to do this, then a corresponding quantity of bonds in the tax-advantaged account(s) could be exchanged for stocks with no tax implications.

Note that it is not necessary to pay off the mortgage entirely. Simply paying it down still takes advantage of the difference in interest rates/yields.
What you propose is a) a pay down not a pay off and b) sacrifices a tax deduction at one's prevailing federal rate for a minuscule interest savings.
There's nothing wrong with paying down and not paying off.

Whether one gets a tax deduction is very specific to the individual. For instance, we haven't been able to deduct mortgage interest for years. And the difference between a mortgage rate and bond yields may not be minuscule.
I would say saving 4% on a mortgage vs saving 24% on one's taxes counts as a minuscule savings, by comparison. You get a tax deduction [savings]when you contribute to a pretax account. I'm not speaking of the mortgage interest deduction. What you wrote is that one can use pre-tax savings to instead pre-pay a mortgage. That is a bad idea in most if not all cases. Right? Or you disagree?
Last edited by Admiral on Wed Sep 04, 2019 11:27 am, edited 1 time in total.

EnjoyIt
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Re: Paying off mortgage early - am I thinking about this right?

Post by EnjoyIt » Wed Sep 04, 2019 11:22 am

international001 wrote:
Wed Sep 04, 2019 10:33 am
EnjoyIt wrote:
Wed Sep 04, 2019 9:26 am
KlangFool wrote:
Wed Sep 04, 2019 8:55 am
stan1 wrote:
Tue Sep 03, 2019 7:23 am
Financial freedom is the ability to do what you want, when you want. Liquidity gives you that ability. Having a high percentage of your non-retirement net worth in illiquid home equity may seem appealing but it does not give you financial freedom.

In the end it is a personal decision. I would only pay off a mortgage if I would still have at least several hundred thousand dollars in taxable accounts left after doing so. If I didn't have that much I would do a mix of taxable investing and paying off the mortgage early. All of that assumes I was already maxing out all retirement accounts.
stan1,

A) I have a 300K 3.49% 30 years fixed-rate mortgage.

B) I have 500K in my taxable account.

C) I maxed up my tax-advantaged accounts.

I do not see a reason that I should pay off my 300K mortgage.

KlangFool
I think there are 2 good reasons to pay down a low interest rate mortgage.
1) You are getting close to retirement and want to be debt free in retirement to minimize sequence of return risk.
2) You are so wealthy that the arbitrage between the lower interest rate and the possible expected higher return on your portfolio are not worth your bother.

I think there are 2 common but poor reasons to pay down a low interest rate mortgage.
1) You overbought on the home and very cashflow poor. Getting that debt down and recasting may change your day to day financial outlook. The better answer is to move, but not everyone can or is wiling to do that.
2) It feels good.
What is low rate? 3.49% is 4.6% (assume you are in 24% tax bracket). Try to get this with any bond
If you have any any bonds or any cash, this is a better option

For simplicity, I'm disregarding liquidity considerations
That is a good question that I do not have the 1 size fits all answer. Personally I use 4% as my cut-off. Anything above that I do not believe the risk is worth the arbitrage. But realistically 4% is an arbitrary number I picked for myself.

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