Input on strategies to pay down a large mortgage 6.375%

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
dkwang
Posts: 5
Joined: Wed May 15, 2024 9:45 am

Input on strategies to pay down a large mortgage 6.375%

Post by dkwang »

Emergency funds: $50K in VUSXX

Debt:
Mortgage $1.85M principal @ 6.375% 7-year ARM

HHI: $550K gross

Tax Filing Status: Married Filing Jointly

Tax Rate: 35% Federal, 9% State

State of Residence: CA

Age: 37

Desired Asset allocation: 100% stocks
Desired International allocation: 0% of stocks

Current Portfolio size: $1.25M investible assets

Taxable - $500K
30% VTSAX
10% Individual Equities

Retirement - $750K
60% VTSAX

_______________________________________________________________

Contributions

New annual Contributions - $86K
$23k His 401K
$23k Her 403B
$40k Taxable brokerage


Questions:
1. I'm debating two paths to paying down our mortgage. I recognize that paying the principal is akin to a guaranteed 6.375% return. My goal is to reduce the mortgage loan down *as much as would be optimal* with a refinance in 5 years time (and hoping that interest rates will be lower at the end of that timeframe).

I'm debating A) a "DCA strategy" of paying down the mortgage over the next few years from our additional savings or B) a "lump sum" strategy of investing our additional savings into our taxable brokerage and waiting for 3-4 years time for when we are about to refinance to pay down a lump sum of principal.

It seems to me this decision is based on my views of the market - DCA strategy seems optimal if I believe the market will return WORSE than 6.375% (nominal growth). Lump sum strategy seems optimal if I believe the market will return BETTER than 6.375% (nominal growth).

Am I thinking about this correctly? And am I thinking about market return being nominal growth if I am comparing to a fixed mortgage interest rate?

2. We have been frugal in our working years to accumulate a nest egg of $1.25M in investible assets. I am also debating whether or not to draw down from the taxable brokerage (and incurring 20% LTCG) to aid in the reduction of mortgage down to $750K. Part of me feels like I don't want to reduce our nest egg below $1M because the snowball effect feels more sizeable with the annual market returns.

Am I thinking about this correctly or do I have some illogical aversion to reducing my investible assets back to the $X00 K's? Should I more strongly consider liquidating a significant portion of my taxable brokerage in order to reduce my monthly mortgage obligations? What's the best way to think about this?

Welcome all input and feedback, thank you.
Last edited by dkwang on Wed May 15, 2024 1:32 pm, edited 1 time in total.
Admiral
Posts: 5082
Joined: Mon Oct 27, 2014 12:35 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by Admiral »

dkwang wrote: Wed May 15, 2024 11:37 am Emergency funds: $50K in VUSXX

Debt:
Mortgage $1.85M principal @ 6.375% 7-year ARM

Tax Filing Status: Married Filing Jointly

Tax Rate: 35% Federal, 9% State

State of Residence: CA

Age: 37

Desired Asset allocation: 100% stocks
Desired International allocation: 0% of stocks

Current Portfolio size: $1.25M investible assets

Taxable - $500K
30% VTSAX
10% Individual Equities

Retirement - $750K
60% VTSAX

_______________________________________________________________

Contributions

New annual Contributions - $86K
$23k His 401K
$23k Her 403B
$40k Taxable brokerage


Questions:
1. I'm debating two paths to paying down our mortgage. I recognize that paying the principal is akin to a guaranteed 6.375% return. My goal is to reduce the mortgage loan down *as much as would be optimal* with a refinance in 5 years time (and hoping that interest rates will be lower at the end of that timeframe).

I'm debating A) a "DCA strategy" of paying down the mortgage over the next few years from our additional savings or B) a "lump sum" strategy of investing our additional savings into our taxable brokerage and waiting for 3-4 years time for when we are about to refinance to pay down a lump sum of principal.

It seems to me this decision is based on my views of the market - DCA strategy seems optimal if I believe the market will return WORSE than 6.375% (nominal growth). Lump sum strategy seems optimal if I believe the market will return BETTER than 6.375% (nominal growth).

Am I thinking about this correctly? And am I thinking about market return being nominal growth if I am comparing to a fixed mortgage interest rate?

2. We have been frugal in our working years to accumulate a nest egg of $1.25M in investible assets. I am also debating whether or not to draw down from the taxable brokerage (and incurring 20% LTCG) to aid in the reduction of mortgage down to $750K. Part of me feels like I don't want to reduce our nest egg below $1M because the snowball effect feels more sizeable with the annual market returns.

Am I thinking about this correctly or do I have some illogical aversion to reducing my investible assets back to the $X00 K's? Should I more strongly consider liquidating a significant portion of my taxable brokerage in order to reduce my monthly mortgage obligations? What's the best way to think about this?

Welcome all input and feedback, thank you.
Welcome to the forum.

What is your HHI? That is a massive mortgage with massive interest being paid. I ask about the income b/c it seems if you can service such a mortgage, then you can/could hopefully save more than $40k in taxable. Does the $23k pp include a match or if that just your money?

While you have $1.25m in "investible" assets, the majority of those assets cannot be used to pay down/off the mortgage. So really, it's the $500k that's available.

Even assuming the market does well and beats your mortgage rate, you will be losing money to ongoing tax drag, and of course to capital gains when you sell. What is this $500k for? That alone is creating tax drag. It's clearly not savings to buy a house (you did that) so what's the purpose of it? You appear to be far from retirement.

In general it's better to pay down the mortgage immediately rather than putting it off by instead choosing taxable investing if you have a high interest-rate mortgage, as you do. You would need to see pretty impressive gains to make that option better, at least financially. I would not save any addl funds in taxable, in fact I would allocate the $40k to the mortgage, add even more if possible from cashflow, and then sell some of the taxable that's at a loss or has a small gain. I would not pay 20% tax on a large lump sum to save 6.xx%.

Are you paying 15% + NIIT or 20%+NIIT on investment gains? (Goes back to the income question.)
er999
Posts: 1466
Joined: Wed Nov 05, 2008 10:00 am

Re: Input on strategies to pay down a large mortgage 6.375%

Post by er999 »

I didn’t like debt so I paid off my mortgage little by little even though that wasn’t the financially optimally strategy. That is a huge mortgage and going from 1.85 million to 1 million balance doesn’t give you much protection if you lose your job since the payments would still be the same. Perhaps recast the mortgage if you pay down so payments will be lower when you pay a chunk down?

I assume you are in tech with living in California and the high tax bracket. If so, I’d consider a bigger emergency fund than $50k with an expensive house and 100% stocks in your portfolio. You don’t want to lose your job at the same time your stocks are down and need to sell to make your mortgage payments. I’d personally build up your safe savings to at least $100k-$200k and then look at paying down the mortgage afterwards.

Re your comment about being frugal — you may have been but not now after borrowing 1.8 million for a house. May still be fine with a big salary (and I’m sure the house is somewhat modest size with the high prices in the area) but that is a lot of spending, $120k in interest payments alone.
jarjarM
Posts: 2543
Joined: Mon Jul 16, 2018 1:21 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by jarjarM »

That looks like a typical bayarea mortgage for younger family that bought within the last 2-3 years. Given that CA is a non-recourse state, it's worthwhile to take that into consideration. Since you're in 35% federal bracket, your LTCG rate is actually 20% + 3.8% NIIT + 9.3% CA state (or higher). If I was in your position, I would definitely reduce my taxable contribution and use that $$$ to reduce the mortgage a bit faster. However, I don't think selling off investments in taxable account (if they have low cost basis) would be worthwhile given the high tax rate and non-recourse action in mind.
tashnewbie
Posts: 4437
Joined: Thu Apr 23, 2020 12:44 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by tashnewbie »

I would at least divert the $40k/year taxable savings to paying down the mortgage to the deductible range ($750k). Refinance in the next 5 years if there is an opportunity.
snowday2022
Posts: 822
Joined: Sun Jan 16, 2022 1:48 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by snowday2022 »

At MFJ and 35% marginal rate, your expenses are probably high, especially with that mortgage. With your current spend it’s not clear to me you can afford to pay it down unless you want to pay CG taxes, but your taxable is serving as your EF basically. You are effectively housepoor. Look closely at your other expenses to see what can be cut. Make more money too.
Rocky Mtn Man
Posts: 471
Joined: Mon Apr 25, 2022 1:58 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by Rocky Mtn Man »

er999 wrote: Wed May 15, 2024 12:11 pm I’d personally build up your safe savings to at least $100k-$200k and then look at paying down the mortgage afterwards.
^ This. I would stop contributing to retirement accounts for the next few years and divert all savings to the emergency fund. Then turn the attention to getting that $120k/year in interest off you back.
CletusCaddy
Posts: 2963
Joined: Sun Sep 12, 2021 4:23 am

Re: Input on strategies to pay down a large mortgage 6.375%

Post by CletusCaddy »

Pay it down to $1M as that is where the tax benefits start
tashnewbie
Posts: 4437
Joined: Thu Apr 23, 2020 12:44 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by tashnewbie »

Rocky Mtn Man wrote: Wed May 15, 2024 12:28 pm
er999 wrote: Wed May 15, 2024 12:11 pm I’d personally build up your safe savings to at least $100k-$200k and then look at paying down the mortgage afterwards.
^ This. I would stop contributing to retirement accounts for the next few years and divert all savings to the emergency fund. Then turn the attention to getting that $120k/year in interest off you back.
This strikes me as odd. Why would they stop retirement contributions and incur a 44% tax cost to increase an emergency fund? They have adequate emergency funds in my opinion between the $50k cash and the $500k in taxable. They can divert the $40k/year going into taxable to mortgage paydown, without changing the 401k contributions.
Topic Author
dkwang
Posts: 5
Joined: Wed May 15, 2024 9:45 am

Re: Input on strategies to pay down a large mortgage 6.375%

Post by dkwang »

Thanks all for the replies. I am in tech in Bay Area and our HHI is $550K gross not including private RSU equity. My spouse is in the hospital field so she has a more stable career.

I agree I am far from retirement but I am 37 so hoping to continue investing towards that goal in my 40's and 50's.
WhiteMaxima
Posts: 3439
Joined: Thu May 19, 2016 5:04 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by WhiteMaxima »

Sell the after tax 500k and pay down the 6.5% mortgage. That's guaranteed 6.5% aft tax return.
Admiral
Posts: 5082
Joined: Mon Oct 27, 2014 12:35 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by Admiral »

WhiteMaxima wrote: Wed May 15, 2024 1:36 pm Sell the after tax 500k and pay down the 6.5% mortgage. That's guaranteed 6.5% aft tax return.
And pay more than 25% in tax? That makes zero sense.
Topic Author
dkwang
Posts: 5
Joined: Wed May 15, 2024 9:45 am

Re: Input on strategies to pay down a large mortgage 6.375%

Post by dkwang »

jarjarM wrote: Wed May 15, 2024 12:17 pm That looks like a typical bayarea mortgage for younger family that bought within the last 2-3 years. Given that CA is a non-recourse state, it's worthwhile to take that into consideration. Since you're in 35% federal bracket, your LTCG rate is actually 20% + 3.8% NIIT + 9.3% CA state (or higher). If I was in your position, I would definitely reduce my taxable contribution and use that $$$ to reduce the mortgage a bit faster. However, I don't think selling off investments in taxable account (if they have low cost basis) would be worthwhile given the high tax rate and non-recourse action in mind.
spot on. We have an effective 30% savings rate on net income which is not great but also not bad considering the high interest rate environment. Hoping to return to a more positive monthly cash flow when I can refinance in a few years while reducing mortgage principal with a lower rate. Also hoping that continuing to max our retirement contributions will suffice for this "housepoor" season.

Thank you for the advice.
vfinx
Posts: 709
Joined: Thu Apr 19, 2018 9:35 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by vfinx »

I wonder if you might consider joining a public company. This is a case where not having access to liquid stock has meaningful impact. If a liquidity event is not imminent I would hunt around. There is now a 6.375% annual tax on your private RSUs that you are pre-paying.
WhiteMaxima
Posts: 3439
Joined: Thu May 19, 2016 5:04 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by WhiteMaxima »

the fed will keep the interest 5.25% a bit longer. I don't think interest will go back to 0.25% in a foreseeable future. Long term inflation will not go back to 2%. 3% is more reasonable number. To to keep the real interest positive. The overnite interest should be 3.5% ish. plus 2% premium. I would guess the mortgage back to 5.5% ish in 2026 and on. Pay down the mortgage might be your best investment at the moment.
Topic Author
dkwang
Posts: 5
Joined: Wed May 15, 2024 9:45 am

Re: Input on strategies to pay down a large mortgage 6.375%

Post by dkwang »

vfinx wrote: Wed May 15, 2024 1:48 pm I wonder if you might consider joining a public company. This is a case where not having access to liquid stock has meaningful impact. If a liquidity event is not imminent I would hunt around. There is now a 6.375% annual tax on your private RSUs that you are pre-paying.
I will strongly consider this. I am at a late stage startup but the liquidity window is more like 3-5 years. Thank you.
jsapiandante
Posts: 309
Joined: Thu Jul 30, 2015 5:58 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by jsapiandante »

You should still max out your 401k. I wouldn't sell any of your taxable unless they're at a loss to avoid paying LTG + NIIT at your tax bracket. What I would do is divert your after tax contribution of $40k/year and do not reinvest the dividends in your taxable to put towards the mortgage. In fact, I'd live a very frugal lifestyle or increase your income for the foreseeable future if this is your choice.I think your emergency fund at that amount is fine since you have a large taxable balance.
User avatar
hand
Posts: 2227
Joined: Sun May 17, 2009 8:42 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by hand »

Admiral wrote: Wed May 15, 2024 1:42 pm
WhiteMaxima wrote: Wed May 15, 2024 1:36 pm Sell the after tax 500k and pay down the 6.5% mortgage. That's guaranteed 6.5% aft tax return.
And pay more than 25% in tax? That makes zero sense.
Apologies if I missed it - 25% tax on what portion of the $500k? How much are we talking in real dollars?

Personally, a one-time LTCG tax hit doesn't feel terrible if it immediately reduces risk and offsets many years of 6.5% interest. With a risky source of income, I wouldn't commit 100% of my funds to paying down debt, and would keep a substantial amount liquid.
WhiteMaxima
Posts: 3439
Joined: Thu May 19, 2016 5:04 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by WhiteMaxima »

dkwang wrote: Wed May 15, 2024 11:37 am Emergency funds: $50K in VUSXX

Debt:
Mortgage $1.85M principal @ 6.375% 7-year ARM

HHI: $550K gross

Tax Filing Status: Married Filing Jointly

Tax Rate: 35% Federal, 9% State

State of Residence: CA

Age: 37

Desired Asset allocation: 100% stocks
Desired International allocation: 0% of stocks

Current Portfolio size: $1.25M investible assets

Taxable - $500K
30% VTSAX
10% Individual Equities

Retirement - $750K
60% VTSAX

_______________________________________________________________

Contributions

New annual Contributions - $86K
$23k His 401K
$23k Her 403B
$40k Taxable brokerage


Questions:
1. I'm debating two paths to paying down our mortgage. I recognize that paying the principal is akin to a guaranteed 6.375% return. My goal is to reduce the mortgage loan down *as much as would be optimal* with a refinance in 5 years time (and hoping that interest rates will be lower at the end of that timeframe).

I'm debating A) a "DCA strategy" of paying down the mortgage over the next few years from our additional savings or B) a "lump sum" strategy of investing our additional savings into our taxable brokerage and waiting for 3-4 years time for when we are about to refinance to pay down a lump sum of principal.

It seems to me this decision is based on my views of the market - DCA strategy seems optimal if I believe the market will return WORSE than 6.375% (nominal growth). Lump sum strategy seems optimal if I believe the market will return BETTER than 6.375% (nominal growth).

Am I thinking about this correctly? And am I thinking about market return being nominal growth if I am comparing to a fixed mortgage interest rate?

2. We have been frugal in our working years to accumulate a nest egg of $1.25M in investible assets. I am also debating whether or not to draw down from the taxable brokerage (and incurring 20% LTCG) to aid in the reduction of mortgage down to $750K. Part of me feels like I don't want to reduce our nest egg below $1M because the snowball effect feels more sizeable with the annual market returns.

Am I thinking about this correctly or do I have some illogical aversion to reducing my investible assets back to the $X00 K's? Should I more strongly consider liquidating a significant portion of my taxable brokerage in order to reduce my monthly mortgage obligations? What's the best way to think about this?

Welcome all input and feedback, thank you.
OP, what if stock market drop 40-50%? Prepay your mortgage and lock 6.5% no risk and no tax investment.
Topic Author
dkwang
Posts: 5
Joined: Wed May 15, 2024 9:45 am

Re: Input on strategies to pay down a large mortgage 6.375%

Post by dkwang »

Thank you all for lending your experience and considering my situation. Many great points and things I did not consider, this was very helpful.

I found the Bogleheads forums almost a decade ago and all of your discourse has been so formative in shaping my investment views, finding this forum was one of the best things that has happened to me from a personal finance standpoint.
bombcar
Posts: 980
Joined: Sun Aug 12, 2007 6:41 pm

Re: Input on strategies to pay down a large mortgage 6.375%

Post by bombcar »

Is that a purchase mortgage? Because in California they're non-recourse, meaning that even if you default on it they can only take the house, and not come after you for any difference.

Worth investigating and checking on. The other big thing to remember is that you can always pay down the mortgage early, but you can't necessarily easily get money back out.
Post Reply