Should we pay our 2.75% interest mortgage sooner?

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joelly
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Should we pay our 2.75% interest mortgage sooner?

Post by joelly »

Hi Everyone,

I am wondering if I should try to pay off my mortgage sooner by doubling up on the monthly principal.

Here is the detail on our mortgage:
Home Value = $620,000
Loan Amount = $454,486
Interest rate = 2.75%
Monthly Principal =$815
Monthly Interest = $1,043
Monthly HOA = $200
Monthly RE Tax = $596

I want to start maximizing our Roth Ira contribution this year plus increasing the emergency fund. 401K is maxed out every year. My 401K balance is $750K.

I am wondering when I should do the following:
1. Maximize his and her Roth Ira.
2. Bump up the emergency fund from 2 months expense ($20K currently) to a year expense ($120K goal).
3. Double up the principal payment on the mortgage.

I can do all 3 at once but I wonder whether it is financially wise to double up on the principal payment. I learned by reading Bogleheads that a house is a fixed assets so it's not liquid. But now I have doubts.

I appreciate any help/advice/recommendation.

Many thanks!

-Joelly
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sergeant
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by sergeant »

The IRA's should be your #1 course of action. The EF increase would be next on my list followed by the mortgage reduction. For me 6 months EF is more than adequate as I had very stable employment.
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EnjoyIt
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by EnjoyIt »

I fully agree that maximizing your Backdoor Roth should be done every year. Next, I wonder what your financial goals are with regards to early retirement, and what your goal number is. Also, do you have a taxable account and what is your asset allocation? Do you have bonds?

With regards to your emergency fund, that is a personal decision. How secure is your job? How comfortable are you with cutting back other expenses if there is an emergency? How likely and quickly are you able to find new employment if you lost your job? On average most would recommend a 3-6 month emergency fund. I used to have a 6 month emergency fund and then once I had a decent sized taxable account I decreased it to 3 months and now I just keep 1-1.5 months of expenses in checking because I have a decent sized taxable account with bonds in it that I can always sell Incase of emergency.

As for your mortgage, you have a low interest rate mortgage. If have any bonds in your retirement accounts, you may be in a decent position to divert all your bond additions towards your mortgage. But, I would not do this until I had a decent sized taxable account so that you still retain decent liquidity. You might ask, what is a decent amount in taxable? That is a personal decision that only you could answer.

So, as a recap. Max out your Roth, then build up your emergency fund to 3-6 months. Then build up a decent taxable investment account. Then pay off your mortgage.

This pathway would historically lead to higher portfolio size while having increased flexibility in an emergency vs paying down a mortgage ASAP.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by Grt2bOutdoors »

IRA's first.
E-fund next.
Mortgage - dead last. I think your IRA's will earn more than 2.75% over its life. The e-fund is to provide you peace of mind, fund that before you lock your money up in a mortgage.
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Loandapper
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by Loandapper »

You've been reading too much Bogleheads if you're considering paying down long-term debt locked at 2.75%. Don't pay an extra penny on that mortgage. Max your retirement accounts. Use any money you were going to use to pay off the mortgage to start a taxable account, and religiously invest there for the next 30 years in low cost index funds. Update this post in Sept. 2050 to let us know how much more money you have than had you paid off that mortgage.
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8foot7
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by 8foot7 »

I understand the allure of a paid-off home but a 2.75% note is, by most accounts, at or under the rate of inflation for many goods, meaning payments on that note over time will get cheaper and cheaper while hopefully your income grows and grows. This isn't even accounting for any tax deductions you get for interest, which I understand are not as common as they once were with the recent tax law changes, but with a loan that size you may be in a position to deduct interest, which makes your effective interest rate even lower, which makes it even less worthwhile to pay down the note.

Think about the bet you're making - by paying down a 2.75% note instead of investing it, you are saying over the term of the loan you don't think your investments can beat 2.75% (or less given tax status). Under 3% is not a high hurdle for stocks to overcome, real or nominal. Most people project market returns depending on individual investments between 5 and 8% for the next few decades.

If you were talking a 6%, 4%, maybe even 3.5% loan, then that'd be one thing, but if you are not maximizing any and all tax-advantaged space to which you have access, or if you have literally any other debt greater than 2.5%, or if you don't have six months liquid, or if you haven't started a college fund, then paying down a 2.75% mortgage is--I'll put it charitably--very much less than optimal. Paying that note down would require me to have excess money coming out of my ears, literally thousands of post-tax dollars extra a month after already investing thousands in taxable.

If this is an important personal goal for you, one approach you can take is to do both! Again if you're maxing out all tax-advantaged stuff like 401ks and IRAs, and you have six months' expenses liquid, then you could say for every ten excess dollars you have every month, seven will go into taxable investments and three will go toward mortgage paydown. Or 8 and 2. Or whatever works, though I'd still very strongly encourage you to reconsider diverting significant funds toward paydown. The probability is that you will end up with more money having kept the mortgage and invested your extra money. But this could be a way to achieve both goals.
Last edited by 8foot7 on Tue Sep 22, 2020 8:32 pm, edited 1 time in total.
informal guide
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by informal guide »

There is a mind set that paying off the mortgage, for those who can, is inherently good (my father did so when he was in his mid-50s).

I took our a 30 year variable rate refinance/cash out mortgage in June 2001 for a house addition- -1 month LIBOR plus 1% ( I paid a point or so). The mortgage company forgot to put in a floor in the documents so I have been living wonderfully ( they asked to amend the floor several years later but i declined).

I believe that you can beat 2.75% nominal interest rate with investment returns. so I'd suggest paying just the minimum, as I mostly have done. Because they neglected to put a floor in the rate, I am enjoying a current interest rate of1.125% today; even 2.75% would continue to encourage me to pay just he minimum and invest the difference in a taxable account, as long as you want an asset allocation of at least 50/50 stocks bonds.
JBTX
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by JBTX »

Agree paying off mortgage is last priority. I wouldn't be rushing to pay 2.75% off, but it really depends on your overall situation. If you have plenty of savings and substantial amounts already in stocks, between 401ks,IRAS and taxable accounts, and will be able to max those out in the future, paying down some on the mortgage may make sense. If you don't have enough invested to meet your retirement goals, then I'd probably take a portion and put in a taxable accounts with equity index funds. Mostly likely I'd probably do some of both, pay a little off and start funding taxable account.

Also, I'd probably fund ibonds and maybe ee bonds before paying it down. Funding a 529 if you have kids may make sense also.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by grabiner »

8foot7 wrote: Tue Sep 22, 2020 8:02 pm I understand the allure of a paid-off home but a 2.75% note is, by most accounts, at or under the rate of inflation for many goods, meaning payments on that note over time will get cheaper and cheaper while hopefully your income grows and grows.
Inflation isn't the right comparison, because your goal is to get the optimal return from the money, and the alternative investment will not match your personal rate of inflation. (You can match the official rate of interest, before tax, by buying I-Bonds.)

Note the word "optimal", not "maximal". You are managing all of your money to trade off between return and risk. If you invest any of your money in Total Bond Market Index, you are accepting a low-risk 1.17% return, even though you might get a higher return by investing in stock. Similarly, if you pay down your 2.75% mortgage, you are accepting a risk-free 2.75% return (which may be less after tax if you are paying off deductible interest). If holding bonds is reasonable, then paying down the mortgage gives a better return with no additional risk, unless you need the liquidity.
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GT99
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by GT99 »

When my mortgage was at 4.125% I planned to start paying it down about 7 or 8 years before retirement. Now that I'm at 2.75%, I doubt I ever will, but if bond returns stay consistently low for a very long term, who knows.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by GT99 »

grabiner wrote: Tue Sep 22, 2020 8:56 pm
8foot7 wrote: Tue Sep 22, 2020 8:02 pm I understand the allure of a paid-off home but a 2.75% note is, by most accounts, at or under the rate of inflation for many goods, meaning payments on that note over time will get cheaper and cheaper while hopefully your income grows and grows.
Inflation isn't the right comparison, because your goal is to get the optimal return from the money, and the alternative investment will not match your personal rate of inflation. (You can match the official rate of interest, before tax, by buying I-Bonds.)

Note the word "optimal", not "maximal". You are managing all of your money to trade off between return and risk. If you invest any of your money in Total Bond Market Index, you are accepting a low-risk 1.17% return, even though you might get a higher return by investing in stock. Similarly, if you pay down your 2.75% mortgage, you are accepting a risk-free 2.75% return (which may be less after tax if you are paying off deductible interest). If holding bonds is reasonable, then paying down the mortgage gives a better return with no additional risk, unless you need the liquidity.
I largely agree, but there is one problem with this line of thinking - if I just refinanced for 30 years and my investment horizon is 30 years, and I pay off the mortgage, that's paying off 2.75% for 30 years. You can't just compare that to current bond returns. Over the long haul, your average return on the bonds highly likely to be much higher than 1.17%. Probably over 3%. But that's part of the risk comparison - do you want the guarantee or the opportunity for higher returns?
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by grabiner »

GT99 wrote: Tue Sep 22, 2020 9:06 pm
grabiner wrote: Tue Sep 22, 2020 8:56 pm
8foot7 wrote: Tue Sep 22, 2020 8:02 pm I understand the allure of a paid-off home but a 2.75% note is, by most accounts, at or under the rate of inflation for many goods, meaning payments on that note over time will get cheaper and cheaper while hopefully your income grows and grows.
Inflation isn't the right comparison, because your goal is to get the optimal return from the money, and the alternative investment will not match your personal rate of inflation. (You can match the official rate of interest, before tax, by buying I-Bonds.)

Note the word "optimal", not "maximal". You are managing all of your money to trade off between return and risk. If you invest any of your money in Total Bond Market Index, you are accepting a low-risk 1.17% return, even though you might get a higher return by investing in stock. Similarly, if you pay down your 2.75% mortgage, you are accepting a risk-free 2.75% return (which may be less after tax if you are paying off deductible interest). If holding bonds is reasonable, then paying down the mortgage gives a better return with no additional risk, unless you need the liquidity.
I largely agree, but there is one problem with this line of thinking - if I just refinanced for 30 years and my investment horizon is 30 years, and I pay off the mortgage, that's paying off 2.75% for 30 years. You can't just compare that to current bond returns. Over the long haul, your average return on the bonds highly likely to be much higher than 1.17%. Probably over 3%. But that's part of the risk comparison - do you want the guarantee or the opportunity for higher returns?
This is correct. The fair comparison is to a bond of the same duration. Paying down the mortgage is equivalent to buying a risk-free 30-year bond if you would otherwise carry the mortgage to term, or a risk-free 10-year bond if you sell the home or refinance again in 10 years. (Paying off the mortgage is equivalent to buying a bond portfolio maturing in 1-360 months, which would have a duration of about 12 years.)

So, if the duration is actually 30 years, a zero-coupon 30-year Treasury currently yields 1.59%. If your mortgage interest is deductible, you need to take only a small amount of risk to match; a 30-year bond portfolio with the risk profile of Vanguard Long-Term Bond Index would be close.

So, is the duration 30 years for the OP, or are they likely to pay it off? Total Bond Market Index is a reasonable comparison for a 6-year duration. (In a higher tax bracket, Vanguard Long-Term Tax-Exempt Admiral shares is also a reasonable comparison, although the 1.58% yield on Admiral shares implies significant credit risk.)

If the interest is deductible at a reasonable rate, I wouldn't pay down the 2.75% loan. I didn't pay down my own 2.625% loan, which was fully deductible and thus 1.78% after tax, until the loan term was down to nine years, and I could pay it all off at once to get a duration of 4.5 years.
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8foot7
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by 8foot7 »

grabiner wrote: Tue Sep 22, 2020 10:50 pm
GT99 wrote: Tue Sep 22, 2020 9:06 pm
grabiner wrote: Tue Sep 22, 2020 8:56 pm
8foot7 wrote: Tue Sep 22, 2020 8:02 pm I understand the allure of a paid-off home but a 2.75% note is, by most accounts, at or under the rate of inflation for many goods, meaning payments on that note over time will get cheaper and cheaper while hopefully your income grows and grows.
Inflation isn't the right comparison, because your goal is to get the optimal return from the money, and the alternative investment will not match your personal rate of inflation. (You can match the official rate of interest, before tax, by buying I-Bonds.)

Note the word "optimal", not "maximal". You are managing all of your money to trade off between return and risk. If you invest any of your money in Total Bond Market Index, you are accepting a low-risk 1.17% return, even though you might get a higher return by investing in stock. Similarly, if you pay down your 2.75% mortgage, you are accepting a risk-free 2.75% return (which may be less after tax if you are paying off deductible interest). If holding bonds is reasonable, then paying down the mortgage gives a better return with no additional risk, unless you need the liquidity.
I largely agree, but there is one problem with this line of thinking - if I just refinanced for 30 years and my investment horizon is 30 years, and I pay off the mortgage, that's paying off 2.75% for 30 years. You can't just compare that to current bond returns. Over the long haul, your average return on the bonds highly likely to be much higher than 1.17%. Probably over 3%. But that's part of the risk comparison - do you want the guarantee or the opportunity for higher returns?
This is correct. The fair comparison is to a bond of the same duration. Paying down the mortgage is equivalent to buying a risk-free 30-year bond if you would otherwise carry the mortgage to term, or a risk-free 10-year bond if you sell the home or refinance again in 10 years. (Paying off the mortgage is equivalent to buying a bond portfolio maturing in 1-360 months, which would have a duration of about 12 years.)

So, if the duration is actually 30 years, a zero-coupon 30-year Treasury currently yields 1.59%. If your mortgage interest is deductible, you need to take only a small amount of risk to match; a 30-year bond portfolio with the risk profile of Vanguard Long-Term Bond Index would be close.

So, is the duration 30 years for the OP, or are they likely to pay it off? Total Bond Market Index is a reasonable comparison for a 6-year duration. (In a higher tax bracket, Vanguard Long-Term Tax-Exempt Admiral shares is also a reasonable comparison, although the 1.58% yield on Admiral shares implies significant credit risk.)

If the interest is deductible at a reasonable rate, I wouldn't pay down the 2.75% loan. I didn't pay down my own 2.625% loan, which was fully deductible and thus 1.78% after tax, until the loan term was down to nine years, and I could pay it all off at once to get a duration of 4.5 years.
Great points and I have sharpened my thinking on the details of this matter.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by kd2008 »

Most of the arguments for and against involve constrained thinking. But your whole financial picture is much more bigger than that.

For example: We got 30-yr mortgage on our new home at 2.875% earlier this year. We invested proceeds from sale of previous home in the market. Already it has gained enough to pay 30% of the lifetime interest of the mortgage in 4 months, and I have liquidity. It is volatile and not guaranteed.

I used to be myopic about guaranteed return as if it were special. But I have realized it does not matter. The total risk profile for the whole portfolio matters. Carrying mortgage or not then becomes moot if you have accounted for it correctly.

How much additional human capital are you going to transform into wealth? over what duration? Those answers will guide you to mortgage payoff decision.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by alex_686 »

Step back and look at your financial picture as a whole. What are your goals, what is your risk tolerance, and how does a mortgage fit.

A mortgage is a negative bond with a option for early pre-pay. As such, it can be a compelling investment.

It is a good hedge against inflation.

Can you earn a higher rate of return in other places? Maybe. This is why you are seeing so many suggestions about investing in retirement accounts. Over the next 10 years equites will likely outperform the 2.75%. That being said, it is a guaranteed 2.75% return if you pay down early.

Consider liquidity. If you invest money into paying down your mortgage that money is locked away unless you do a cash-out refi. This can be costly and expensive. Not just the upfront fees, but will you be able to refi at 2.75? There is a edge case here where one has the assets but limited income. Think of somebody retired living off of pensions and social security.

So you see that we would need to see what your portfolio and goals are.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by MortgageOnBlack »

We have a 2.625% 15 year mortgage (~$190k remaining) and throw an extra $200 a month on it. Even with this extra $200, I'm still savings 1/3 of my take-home in investments and I get satisfaction knowing we could never buy another house in our area for what we owe. I imagine if we paid the minimum on a 30-year, there would be more temptation to sell to "upgrade". From this perspective, it's saving us money and keeping us content and happy with what we have. This is well worth it to me to keep up with our current plan. I'm learning to love our house more and more every time I see the mortgage statement.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by Admiral »

If the interest to principal ratio is that high, I suspect this is a 30 year note. I suggest a refi to a 15 year. At least then, more of your payment will go to principal.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by LuckyGuy »

We paid off our house in our 40’s. I didn’t care what the interest rate was. I didn’t like owing anyone any money. Note that we were maxing out our 401k’s and IRA’s as well. But it sounds as you are doing that also. I personally feel the inner peace of not owing anyone for anything trumps any sort of dollar value.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by Admiral »

LuckyGuy wrote: Wed Sep 23, 2020 3:56 pm We paid off our house in our 40’s. I didn’t care what the interest rate was. I didn’t like owing anyone any money. Note that we were maxing out our 401k’s and IRA’s as well. But it sounds as you are doing that also. I personally feel the inner peace of not owing anyone for anything trumps any sort of dollar value.
Certainly not going to argue about your emotions, but I'd point out that you will owe something (often a lot) to someone for as long as you own your home: namely, real estate taxes.

"Owing" is perhaps a state of mind.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by LuckyGuy »

Admiral wrote: Wed Sep 23, 2020 4:12 pm
LuckyGuy wrote: Wed Sep 23, 2020 3:56 pm We paid off our house in our 40’s. I didn’t care what the interest rate was. I didn’t like owing anyone any money. Note that we were maxing out our 401k’s and IRA’s as well. But it sounds as you are doing that also. I personally feel the inner peace of not owing anyone for anything trumps any sort of dollar value.
Certainly not going to argue about your emotions, but I'd point out that you will owe something (often a lot) to someone for as long as you own your home: namely, real estate taxes.

"Owing" is perhaps a state of mind.
I’m not going to argue that. I still owe taxes and insurance too. I’m not as emotional about those. Mostly just annoyed :happy

Honestly though most of my deep rooted dislike of being in debt was growing up poor and watching my mom work at night to pay off credit card bills for our school clothes and supplies. Of course I had lots of hand me downs from my 8 older siblings but the mighty Montgomery Ward’s credit card caused much stress to my mom.

But my point was that I wanted to let the OP not everyone here makes purely financial decisions. Personal finance is personal.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by grabiner »

kd2008 wrote: Wed Sep 23, 2020 10:15 am Most of the arguments for and against involve constrained thinking. But your whole financial picture is much more bigger than that.

For example: We got 30-yr mortgage on our new home at 2.875% earlier this year. We invested proceeds from sale of previous home in the market. Already it has gained enough to pay 30% of the lifetime interest of the mortgage in 4 months, and I have liquidity. It is volatile and not guaranteed.

I used to be myopic about guaranteed return as if it were special. But I have realized it does not matter. The total risk profile for the whole portfolio matters. Carrying mortgage or not then becomes moot if you have accounted for it correctly.
This is almost right. The total risk portfolio for your financial situation matters, not just your portfolio. If you have a $600K portfolio which is half stock, and you sell $100K of bonds and $100K in stock to pay down your mortgage, you have decreased your risk; a 50% stock market crash will now cost you $100K rather than $150K of money you can spend in retirement. Conversely, if you sell $200K of bonds to pay down your mortgage, then even though your portfolio is now 75% stock, you aren't taking any more risk.

The same principle applies for other transactions which take money out of your portfolio, or put money in. If you have a similar portfolio and decide to buy an annuity, you get a fair comparison if you sell bonds; $300K in stock, $100K in bonds, and a present value of $200K in future annuity payments is no riskier than $300K in stock and $300K in bonds.

And that is as it should be, because paying off a mortgage is a fixed-term annuity. If you pay off a mortgage, you get a guaranteed amount of money every future month equal to the mortgage payment you don't have to make, until the mortgage would have been gone on its own.

I would not recommend paying down a 2.875% 30-year mortgage (nor the OP's 2.75%) if the interest is deductible, or if you are not maxing out retirement accounts. You do get a risk-free return, but 2.875% for a very-long-term risk-free return isn't a great deal.
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by EnjoyIt »

grabiner wrote: Wed Sep 23, 2020 6:43 pm
kd2008 wrote: Wed Sep 23, 2020 10:15 am Most of the arguments for and against involve constrained thinking. But your whole financial picture is much more bigger than that.

For example: We got 30-yr mortgage on our new home at 2.875% earlier this year. We invested proceeds from sale of previous home in the market. Already it has gained enough to pay 30% of the lifetime interest of the mortgage in 4 months, and I have liquidity. It is volatile and not guaranteed.

I used to be myopic about guaranteed return as if it were special. But I have realized it does not matter. The total risk profile for the whole portfolio matters. Carrying mortgage or not then becomes moot if you have accounted for it correctly.
This is almost right. The total risk portfolio for your financial situation matters, not just your portfolio. If you have a $600K portfolio which is half stock, and you sell $100K of bonds and $100K in stock to pay down your mortgage, you have decreased your risk; a 50% stock market crash will now cost you $100K rather than $150K of money you can spend in retirement. Conversely, if you sell $200K of bonds to pay down your mortgage, then even though your portfolio is now 75% stock, you aren't taking any more risk.

The same principle applies for other transactions which take money out of your portfolio, or put money in. If you have a similar portfolio and decide to buy an annuity, you get a fair comparison if you sell bonds; $300K in stock, $100K in bonds, and a present value of $200K in future annuity payments is no riskier than $300K in stock and $300K in bonds.

And that is as it should be, because paying off a mortgage is a fixed-term annuity. If you pay off a mortgage, you get a guaranteed amount of money every future month equal to the mortgage payment you don't have to make, until the mortgage would have been gone on its own.

I would not recommend paying down a 2.875% 30-year mortgage (nor the OP's 2.75%) if the interest is deductible, or if you are not maxing out retirement accounts. You do get a risk-free return, but 2.875% for a very-long-term risk-free return isn't a great deal.
One’s risk profile is a very personal thing and psychology plays a huge role here. If one is able to maintain a higher asset allocation by leveraging a mortgage, they have a higher expected return compared to incorporating their mortgage to their AA. Most people and even financial advisors do just that. Vanguard’s target date funds don’t adjust their bond holdings based on how much mortgage you have. Unless one is very risk averse, one should probably delay this whole “mortgage as a negative bond” thinking for many years and revisit it when they are getting close to being financially independent.
A time to EVALUATE your jitters: | https://www.bogleheads.org/forum/viewtopic.php?f=10&t=79939&start=400#p5275418
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Re: Should we pay our 2.75% interest mortgage sooner?

Post by Admiral »

EnjoyIt wrote: Wed Sep 23, 2020 11:53 pm
grabiner wrote: Wed Sep 23, 2020 6:43 pm
kd2008 wrote: Wed Sep 23, 2020 10:15 am Most of the arguments for and against involve constrained thinking. But your whole financial picture is much more bigger than that.

For example: We got 30-yr mortgage on our new home at 2.875% earlier this year. We invested proceeds from sale of previous home in the market. Already it has gained enough to pay 30% of the lifetime interest of the mortgage in 4 months, and I have liquidity. It is volatile and not guaranteed.

I used to be myopic about guaranteed return as if it were special. But I have realized it does not matter. The total risk profile for the whole portfolio matters. Carrying mortgage or not then becomes moot if you have accounted for it correctly.
This is almost right. The total risk portfolio for your financial situation matters, not just your portfolio. If you have a $600K portfolio which is half stock, and you sell $100K of bonds and $100K in stock to pay down your mortgage, you have decreased your risk; a 50% stock market crash will now cost you $100K rather than $150K of money you can spend in retirement. Conversely, if you sell $200K of bonds to pay down your mortgage, then even though your portfolio is now 75% stock, you aren't taking any more risk.

The same principle applies for other transactions which take money out of your portfolio, or put money in. If you have a similar portfolio and decide to buy an annuity, you get a fair comparison if you sell bonds; $300K in stock, $100K in bonds, and a present value of $200K in future annuity payments is no riskier than $300K in stock and $300K in bonds.

And that is as it should be, because paying off a mortgage is a fixed-term annuity. If you pay off a mortgage, you get a guaranteed amount of money every future month equal to the mortgage payment you don't have to make, until the mortgage would have been gone on its own.

I would not recommend paying down a 2.875% 30-year mortgage (nor the OP's 2.75%) if the interest is deductible, or if you are not maxing out retirement accounts. You do get a risk-free return, but 2.875% for a very-long-term risk-free return isn't a great deal.
One’s risk profile is a very personal thing and psychology plays a huge role here. If one is able to maintain a higher asset allocation by leveraging a mortgage, they have a higher expected return compared to incorporating their mortgage to their AA. Most people and even financial advisors do just that. Vanguard’s target date funds don’t adjust their bond holdings based on how much mortgage you have. Unless one is very risk averse, one should probably delay this whole “mortgage as a negative bond” thinking for many years and revisit it when they are getting close to being financially independent.
+1. If I have already chosen my asset allocation to account for my risk tolerance, I see no need to adjust it based on the fact that I have a mortgage (or not). That's presumably already factored into my calculations. That's why I only compare my mortgage rate to expected total portfolio return, not to bond return.

Further, if I hold a 100k mortgage and have $100k in taxable assets, the mortgage carries no "risk" (in the traditional sense) since it can be paid off at will. The only risk is that the house may be a poor investment, but that's independent of whether or not one has a mortgage.
Topic Author
joelly
Posts: 282
Joined: Mon Oct 27, 2008 11:22 am

Re: Should we pay our 2.75% interest mortgage sooner?

Post by joelly »

Thank you for all these responses. I am overwhelmed with the knowledge you all share with me.

Yes, I do read too much Bogleheads.

So I need to focus on getting a Roth IRA then EF then paying off the house. I like the idea on start paying off the house around 7-8 yrs before retiring.

I just find out that I have to use the backdoor roth ira because we pass the income limit :oops:
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