A new debate on paying off the mortgage (or not).

[Nords]

We've been debating whether it's better to pay off the mortgage or to invest it in higher-return assets (whatever those are). Aside from smiting each other mightily with calculators & statistical theory, IMO to this point the debate has only been a reciprocal diatribe without persuasion. We still have our mortgages.

Linda Stern takes an asset-allocation approach. It doesn't have much to do with the previous debates about historical returns & calculators, so please restrict those comments to that thread. But take a look in this thread at how your own portfolio is affected by a mortgage.

Reuters Finance: Should You Prepay Your Mortgage?

http://www.reuters.com/newsArticle....ECRBAEZSFEY?type=businessNews&storyID=5008611

According to the article, our own retirement portfolio has risen by our home value (again, "whatever that is") and our mortgage has pushed our asset allocation from 0% bonds to -25%. We haven't included our home equity in our retirement portfolio, and I'm still trying to decide if this is deworsification!

But asset allocation may only be a different approach to solving part of the mortgage problem. In the back half of the article, she gives a nod to the other concerns that we've already brought up.

 

[cute fuzzy bunny]

Re: A new debate on paying off the mortgage (or no

Nords -

This was actually my core point that was apparently lost in the "smiting". In short, replace the mortgage with a portion of your fixed income investment money.

After doing so, one can leave their portfolio with a higher ratio of stocks, which by historical analysis would provide a higher rate of return. Or one can rebalance to the same allocation or one that is lower in volatility due to the lower SWR requirements.

Unless you're getting the current mortgage rate as a low risk bond return (minus taxes and expenses) or forsee that return in the next few years. Right now even high yield bonds are barely beating the mortgage rate, and thats before taxes.

 

[charlie]

Re: A new debate on paying off the mortgage (or no

I have a home equity loan at 3.95% which will be
paid off in 5 years. I could pay it off but have chosen
not to do so at this time. But, I reserve the right to
do so if it seems appropriate in the future. Seems
like a no brainer to me for my situation.

Personally, I do not consider my home as part of
my portfolio in any way other than as an improbable
source of funds if it becomes necessary. We hope
to live here happily ever after and let the kids deal
with the house and all our accumulated junk. Serves
them right!

Cheers,

Charlie (aka Chuck-Lyn)

 

[unclemick]

Re: A new debate on paying off the mortgage (or no

? Am I reading the link right? Over a long span, say 30 yr fixed, then there are likely to be periods where the numbers say pay ahead on your mortgage by the amount you're allocating to bonds and then buy bonds when the interest rate exceeds your fixed mortgage by enough to make them the better buy.
I.e. switch as the numbers/interest rate changes?

 

[charlie]

Re: A new debate on paying off the mortgage (or no

The main reason I am reluctant to pay off the
home equity loan is that it would tie up a big
part of my after tax savings and reduce future
options. In my case, my small business just
about covers the monthly payment. If I sell
the business in the next 5 years, I will likely
pay off the loan ... but who knows how I will
see things at that time?

GDER, I would not borrow money on the house to
invest it. That's called "leverage", if I am not mistaken,
and seems risky as hell to me if you put it into anything
other than US Gov debt or AAA bonds. You might be
able to cover the interest on your mortgage with
interest earned on "safe" bonds, but you would not
be able to cover principal payments. You might be
able to take out a "balloon" mortgage and cover the
payoff with bonds maturing at the same time as the
mortgage but that seems like a lot of running in place
to me.

Cheers,

Charlie (aka Chuck-Lyn)

 

[Pete]

In the book Ordinary People Extraordinary Wealth you get many reasons to keep your mortgage. I paid off my mortgage and the benefits were mostly psychological. I feel real peace of mind and it convinced me to leave work early.

 

[ziggy29]

Well, here's another way to look at it.

Let's say you have the ability to pay off a $100,000 mortgage at (say) 6%. You ask whether or not you should pay off the mortgage. A lot of people would say no because you can likely invest it at a higher long-term return, plus potential tax breaks for keeping the mortgage.

Now ask the same people: If you owned your home free and clear, would you borrow $100K against it at 6% to invest?

A lot of the people who would NOT pay off the home with a $100,000 lump-sum windfall would also NOT go $100K into debt to invest.

But these are essentially identical situations; the choice is whether you prefer to have $100,000 and a $100K mortgage or you have a paid-off home. But sentiment often changes depending on which way you approach it.

 

[M Paquette]

In my case, I retired when the mortgage was paid off, because I knew that at that point I'd have an exciting new budget item coming in to replace it, the family medical insurance.

The insurance budget is pretty close to what the old mortgage payment was.

 

[gettingthere]

Well, here's another way to look at it.

Let's say you have the ability to pay off a $100,000 mortgage at (say) 6%. You ask whether or not you should pay off the mortgage. A lot of people would say no because you can likely invest it at a higher long-term return, plus potential tax breaks for keeping the mortgage.

Now ask the same people: If you owned your home free and clear, would you borrow $100K against it at 6% to invest?

A lot of the people who would NOT pay off the home with a $100,000 lump-sum windfall would also NOT go $100K into debt to invest.

But these are essentially identical situations; the choice is whether you prefer to have $100,000 and a $100K mortgage or you have a paid-off home. But sentiment often changes depending on which way you approach it.

Ziggy, I like this way of looking at it.

Intellectually I know I could do better investing the extra I am paying down each month, but emotionally, I want to see that mortgage paid off by the time I retire.

It helps to be able to look at the question this way.

 

[Notmuchlonger]

I cant find the article to the link anymore. If anyone has it please re-link.

Thanks

 

[Texas Proud]

I cant find the article to the link anymore. If anyone has it please re-link.

Thanks

I looked... an OLD thread... long gone...

 

[OAG]

This was a 4 year old thread - of course the link is gone.

 

[Notmuchlonger]

Ha I thought it was just last week Necro threads..

 

[donheff]

Well, here's another way to look at it.

Let's say you have the ability to pay off a $100,000 mortgage at (say) 6%. You ask whether or not you should pay off the mortgage. A lot of people would say no because you can likely invest it at a higher long-term return, plus potential tax breaks for keeping the mortgage.

Now ask the same people: If you owned your home free and clear, would you borrow $100K against it at 6% to invest?

A lot of the people who would NOT pay off the home with a $100,000 lump-sum windfall would also NOT go $100K into debt to invest.

But these are essentially identical situations; the choice is whether you prefer to have $100,000 and a $100K mortgage or you have a paid-off home. But sentiment often changes depending on which way you approach it.

Yeah, I have wondered about the same thing. I know people who refinanced to pull cash out for a home addition, to buy other property (I did that), to pay off other loans... all sorts of things. But I have never personally met anyone who pulled equity out of their home to invest in the market. I assume there are such people but they seem to be as rare as hen's teeth. Yet, as you say, it appears to be essentially the same thing as choosing not to use cash equivalent funds to pay off an existing mortgage. Seems to expose a weird quirk in our psychology. I guess I am partially guilty myself. I am sitting on cash right now that is earmarked to pay off the mortgage on our weekend place (already paid off the primary). But I won't do so until DW fully pulls out of work. The tax deduction swings our decision now with a continuing high income. When we switch over to a withdrawal mode and are looking at the cost in portfolio to fund the SWR to pay the mortgage the subjective comfort factor tilts us in the other direction.

 

[bright eyed]

Yeah, I have wondered about the same thing. I know people who refinanced to pull cash out for a home addition, to buy other property (I did that), to pay off other loans... all sorts of things. But I have never personally met anyone who pulled equity out of their home to invest in the market. I assume there are such people but they seem to be as rare as hen's teeth. Yet, as you say, it appears to be essentially the same thing as choosing not to use cash equivalent funds to pay off an existing mortgage. Seems to expose a weird quirk in our psychology. I guess I am partially guilty myself. I am sitting on cash right now that is earmarked to pay off the mortgage on our weekend place (already paid off the primary). But I won't do so until DW fully pulls out of work. The tax deduction swings our decision now with a continuing high income. When we switch over to a withdrawal mode and are looking at the cost in portfolio to fund the SWR to pay the mortgage the subjective comfort factor tilts us in the other direction.

I've been working over in my head the basic idea that Ziggy outlined - and the usual argument in favor of not paying (that' i've observed) is the "tax break" - how much difference does that make? Does it say offset the interest you are paying on the loan by a significant amount (combined then w/ the $ you are earning in investments - makes "not paying" a better financial solution?)

We rent but I'm starting to snoop around home values in our area which have FINALLY become within our reach - and the "total cost of loan" basically stunned me out of looking for a while until I can better understand the math! That alone made me feel like paying off earlier was worth it...my parents paid double digit interest in the 80's on the house i'm in now...so the relatively low rates now still put the fear of the universe in me...

 

[cute fuzzy bunny]

The tax break is only interesting if you're still working. If you're retired with a mortgage, you have to withdraw $xx to pay the mortgage and pay taxes on that excess withdrawal, in order to receive the offsetting tax break. Not only no free lunch, no lunch at all.

Works if you're accumulating, but if you're accumulating, not within a few years of retirement, and dutifully holding 20-40% of your portfolio in bonds paying 3-5% while paying a 5-6%+ mortgage...well...that math is even easier.

 

[Khan]

But I have never personally met anyone who pulled equity out of their home to invest in the market.

I haven't met such folks either.

I do recall reading many proposals to do so in the late 1990s.

 

[TickTock]

Money magazine regularly recommends pulling equity out of the house and investing it in the market on their 'One Family's Finances' (or whatever the proper title is) column.

Bleh. My suggestion - with $800,000 equity in your $1,100,000 home, sell the freaking home, buy a $300,000 home outright and invest the $500,000!

But that's just me.

On taking out a loan at 5.5% (or whatever) and investing it in a balanced AA - yes, the long-term math favors it... BUT! in the short term, you can't predict how markets will perform. If they underperform the expected return for the next ten years, how does it affect your plans? (Doesn't necessarily tip the decision one way or the other, but it should be considered.) For me, the certainty of lower monthly expenses via paying off the mortgage trumps the expected higher return of borrowing and investing. I'm fiscally conservative that way.

 

[donheff]

I've been working over in my head the basic idea that Ziggy outlined - and the usual argument in favor of not paying (that' i've observed) is the "tax break" - how much difference does that make? Does it say offset the interest you are paying on the loan by a significant amount (combined then w/ the $ you are earning in investments - makes "not paying" a better financial solution?)

For most people considering buying a home there isn't much choice. You don't have enough to buy it outright so you are going to take out a big loan. It is usually a bit cheaper to rent x sq ft in a given area than to buy. But in the early years of a loan almost everything you pay is interest and thus deductible (AMT is a danger here). If you are a big wage earner that could mean that you get back 36 cents for every dollar you pay from the Feds plus whatever from the state. That can make a mortgage seem a lot easier to live with. As the years go buy, you are still paying the same mortgage but rents have (probably) gone way up. Makes you feel downright self satisfied. At some point you have paid back a lot of the loan and the deductible portion of your payment isn't so big. Back in the day, though, you could just refinance and pick up a new 30 year loan on the remaining principle at a lower rate than you had before. Now your deduction is back up and you are probably paying less. But that was when rates kept dropping -- now they are as low as they will go.

Get out your spreadsheets and do the math. I never did

 

[bright eyed]

For most people considering buying a home there isn't much choice. You don't have enough to buy it outright so you are going to take out a big loan. It is usually a bit cheaper to rent x sq ft in a given area than to buy. But in the early years of a loan almost everything you pay is interest and thus deductible (AMT is a danger here). If you are a big wage earner that could mean that you get back 36 cents for every dollar you pay from the Feds plus whatever from the state. That can make a mortgage seem a lot easier to live with. As the years go buy, you are still paying the same mortgage but rents have (probably) gone way up. Makes you feel downright self satisfied. At some point you have paid back a lot of the loan and the deductible portion of your payment isn't so big. Back in the day, though, you could just refinance and pick up a new 30 year loan on the remaining principle at a lower rate than you had before. Now your deduction is back up and you are probably paying less. But that was when rates kept dropping -- now they are as low as they will go.

Get out your spreadsheets and do the math. I never did

Yes - that is what i'll have to do. We're somewhat protected cuz we're renting from my parents and paying WAY below market - but they could end up needing to selling it - so i'm giving myself about a 3-5 year window to figure it all out and decide what to do! In that time we should have enough saved for about 10% or more down on a home in socal...which we don't now...

 

[gerrym51]

if your house is paid off- its one more potential asset if you need it.

my home has been paid off for several years. my wife and i only take
the standard dedution on taxes. without mortgage interest we
no longer itemize.


keep it paid . use if needed


gerry

 

[hankster]

Well, here's another way to look at it.

Let's say you have the ability to pay off a $100,000 mortgage at (say) 6%. You ask whether or not you should pay off the mortgage. A lot of people would say no because you can likely invest it at a higher long-term return, plus potential tax breaks for keeping the mortgage.

Now ask the same people: If you owned your home free and clear, would you borrow $100K against it at 6% to invest?

A lot of the people who would NOT pay off the home with a $100,000 lump-sum windfall would also NOT go $100K into debt to invest.

But these are essentially identical situations; the choice is whether you prefer to have $100,000 and a $100K mortgage or you have a paid-off home. But sentiment often changes depending on which way you approach it.

I've asked people this question and the answer is invariably "Hell no!" It causes them to consider the risk aspect of owing money on the home to invest. Call me simple, but they can have their "spread" between the mortgage interest rate and investment return. I have no intention of carrying a mortgage into retirement.

 

[dgalbraith100]

I've asked people this question and the answer is invariably "Hell no!" It causes them to consider the risk aspect of owing money on the home to invest. Call me simple, but they can have their "spread" between the mortgage interest rate and investment return. I have no intention of carrying a mortgage into retirement.

I did "borrow" money and put it into the market, not quite as directly as having a paid off house and borrowing against it, but darn close.

When I bought my current home, I could have paid cash for it. I didn't do that, instead I took the biggest mortgage I could get with favorable terms. I then invested all my "extra" cash from selling the previous home into the market. It does make a difference that I am still in the accumlation phase, not the retired phase. What will I do when I retire, I don't know for sure. I'll think hard about it when I reach that point.

Being able to borrow money at 5.25% is pretty cheap money. So far, since I did this, I'm "winning" from the decision.

Laters,
-d.

 

[cute fuzzy bunny]

Hmm, I paid of my 6% mortgage in 2000. Avoided losing half of what I spent doing that if I'd have left it in the market. Then avoided being paid <5% rates on fixed income interest over the last 8 years. Avoided paying taxes almost every year by having a small annual withdrawal amount. Had a simpler tax preparation by not itemizing. Avoided any concerns about market volatility because I dont have to liquidate any assets into a down market.

So...I guess it depends a bit on your timing and strategy.

A lot of the "solid math" that goes into these calculations presumes a 30 year stay in the home and all the numbers run on a 30 year basis. Given brass balls and an unwavering focus on leaving things alone, that works great. All 20+ year numbers show a greater equity return than the same period mortgage rates. For significantly less than 100% equity holdings the numbers close up a bit.

Taken on a 7-10 year basis, which is greater than the standard time the vast majority of people hold a single mortgage, the average period gains vs period mortgage rates produces a losing proposition about half the time.

Sleep at night factors also vary wildly.

Its simple investing on margin. Playing with the rates and time frames are just convenient excuses. The bottom line is that people are cultured to accept a mortgage debt as reasonable, ordinary and standard. Margin debt or taking a loan to invest is not so well inured.

 

[Alan]

But in the early years of a loan almost everything you pay is interest and thus deductible (AMT is a danger here). If you are a big wage earner that could mean that you get back 36 cents for every dollar you pay from the Feds plus whatever from the state. That can make a mortgage seem a lot easier to live with.

You need to do your analysis on the tax break as you may not get back as big as a break as you think. For example, if you live in a state with no income tax and have few or no other deductions then your deductions probably add up to less than the standard deduction ($10,700 for married filing jointly in 2007). Suppose your itemized deductions add up to $5,000 and your mortgage interest is $6K then you are only getting a tax break on $300. (AMT is also a big concern as donheff points out)