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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 09:10 AM   #21
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Re: Advice....Should I look at home equity this way?

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Is that where you call up your ex on the phone and yell "**** YOU!" ?

Back to the topic at hand, although I'll say for the third time that people are getting too hung up on the technical comparison of a house and a bond and not considering the financial implications within ones total holdings.

A home: usually stable value, appreciates with inflation (ok, most of the time), interest rate sensitive (although usually low, its postulated that the low lending rates sparked the housing boom and I think theres something to that), potentially income producing if you rent a room or rent the whole thing, and avoidance of paying the "bond to the lender" conserves both the payment as cash flow and the interest rate to be paid as a 'coupon'.

A bond: Wow, almost the same thing?

I guess the serious question to be re-asked is this: given the scenario where you have a 250k home with a 200k mortgage at 6% (about the current rate) and a second scenario where you have a paid off 250k home but 200k less in your portfolio...in the latter scenario do you do anything at all differently with how you allocate your funds and what your investment objectives are, and is your risk tolerance any different between the two scenarios.

Before wab or sg spends half an hour contorting themselves to answer the question in a manner to disagree with me, i'll answer first.

Of course i'm going to allocate differently. I've probably cut my spending cash flow by 25-50%. I'm not paying hundreds of thousands of dollars in interest over the next 20 years. I can become more conservative or more aggressive and take more volatility. My overall risk in the latter scenario is lower, although i've increased portfolio risk by reducing the size of the portfolio i've slashed bankruptcy risk by eliminating the largest source of non-controllable spending.

Makes absolutely no sense if you try to jam it into a 1:1 apples to apples comparison. It only makes sense if you look at your entire financial picture in whole. Lots of people have trouble doing that.

Its not a bond, its somewhat "like" a bond in some respects, but its effect on my financial picture? About the same.
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 09:19 AM   #22
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Re: Advice....Should I look at home equity this way?

What an efficient learning tool this forum is....

I went to bed last night with sugarplums dancing in my head and got all sorts of debate on my question from yesterday!

CFB and Wab, especially to you....thanks - your insight (and humor) are assets to the board.

Such a balnced array of opinions from all leads me to the conclusion that:

- A paid off house is not a bond.
- Yet, for overall portfolio purposes, home equity could be broadly categorized as such with sometimes similar and sometimes not similar performance to a bond - depending on many factors. My conclusion - a paid off house in a "squiggly state" probably correlates closer to a bond than they do equities, a hedge fund or pork bellies.
- Having no mortgage payment is good to keep overall expenses lower.
- The need for a more conservative portfolio to ensure payment of those expenses is lessened, especially with a longer time horizon.
- Finally, As a result of this advice - I will stick to my initial thoughts and take on a somewhat more aggressive stance in equities - say 65-67% vs. 60% - as a result of having the house paid off in a traditionally insulated local market and a somewhat longer horizon than those north of 50.

Bottom line, the home equity provides for a comfort zone to take on marginally more performance and risk than otherwise would be prudent.

Thanks again.....
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 10:14 AM   #23
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Re: Advice....Should I look at home equity this way?

Somehow you read through all the chaff, smart pills, sports references and phone sex and seem to have come to a reasonable conclusion for your particular situation.

Good job!
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 12:14 PM   #24
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Re: Advice....Should I look at home equity this way?

Sometimes a house is just a home.
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 01:21 PM   #25
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Re: Advice....Should I look at home equity this way?

i have no idea why i'm living in a ~$400k house. when i bought 12 years ago it was a $70k house. i'd be very happy just living as a vagabond renting 6 months here or a year there, or settle into a $150k house with occasional travel or cruising nonstop in a $250k boat. (that's how you know a true boater: he'll pay more for the boat than the house.) i've been living in this expensive area for 30something years, held here for the last decade by family. while enjoying my garden up to now, when i consider that it might be underwater in 100 years, i no longer feel like i'm guardian of that.

so i don't consider my house just a house, i consider it as part of my net worth. also, since the inherited house has lost so much value, i almost have to consider my house as part of my net worth. i too am confused as to how to look at home equity in regard to constructing a swr for the next five years.

once a house is put into the "it's part of my net worth" catagory, what are the practical & legitimate ways to incorporate the house into swr calculations?

do i separate house into how it will be used into the future? for instance. say i am going to sell & downsize in five years. can i put $250k (400-150 downsized house) into future addition with appropriate year under "one time change to portfolio" while also adding the reverse mortgage dollars based on the $150k house to be purchased in 5 years to the "decrease withdrawals" section.

or if i think i will take to travel and so might live like a vagabond into the future, should i take the entire current value of the house and add that as a one time change to portfolio in five years?

do i do these scenarios for 5 years out? 10 years? and then see where i am at that point and what i can afford to do from there? is this too risky a way to manage my future?
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 01:40 PM   #26
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Re: Advice....Should I look at home equity this way?

Since appreciation on my house has averaged around 2.5%, I don't consider it much of an "investment. Plus, if I sell, I'll need to do some fixin', and pay the realtor...

Might have a different opinion with 10% appreciation...

I've probably not seen ANY actual appreciation, given the two plumbing catastrophes, the new A/C unit, the constant struggle to keep a lawn and what passes for landscaping alive, killing termites and fireants, patching roof leaks, replacing and repairing faucets and toilets, applying bandaids to my aging and ailing sprinkler system...

A lot o' work and expense, though luckily? I can do most of the maintenance and repairs myself...

I do like having a garage, and enjoy the privacy!
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 04:52 PM   #27
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by Cute Fuzzy Bunny
You can always sell and downsize or sell and rent, so its a fairly liquid asset as well.
So the theory is that I can hold more equities in my portfolio because I have home equity that can be monetized, if needed, to provide the stability I'd ordinarily look for in a bond portfolio?

So when the economy is in the crapper and my equities are tanking I'm supposed to sell my house and rent? I imagine I'll get top dollar on that trade. Sure, I could borrow against it, but lenders typically look askance at non-working folks of diminishing net worth trying to borrow against what is likely a depreciating asset (given the economic assumption referenced earlier). And payments on the borrowed money increase your withdrawal rate at the very time you should be reducing it.

Even if that scenario made sense, you'd have to go into this asset allocation scheme with the full knowledge that your withdrawal strategy anticipates you selling your home and moving. Most people construct portfolios so that they can avoid being forced from their homes.
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 05:06 PM   #28
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Re: Advice....Should I look at home equity this way?

Seems that you've interpreted everything I said as far foolish as possible and shoved a bunch of words in my mouth. Give me a break.

Save me a little time too...re-read what I said and then try to explain to me how you came up with this stuff.
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 05:08 PM   #29
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by Cute Fuzzy Bunny
Absolutely the home is part of your "bond" holdings, at least thats the way I look at it. People hold bonds to provide stability and income in their portfolio. Living in a paid off house removes much of the need for stability and income in your portfolio.

You can always sell and downsize or sell and rent, so its a fairly liquid asset as well.

The whole 800k acts exactly like a "bond" with regards to your investing decisions, IMO.

So I interpreted the preceding quote as follows:

Quote:
Originally Posted by 3 Yrs to Go
So the theory is that I can hold more equities in my portfolio because I have home equity that can be monetized, if needed, to provide the stability I'd ordinarily look for in a bond portfolio?

Still seems like a fair interpretation.

You may disagree with what I consider to be the logical implications of using your house as a bond (i.e. potentially having to monetize it), but I don't think I put words in your mouth.

I'm also a bit curious how you rebalance your portfolio. Build a deck when times are good, sell a bedroom on the downturn.

A house is not a bond and I think it is a mistake to structure a portfolio assuming it is.
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 06:05 PM   #30
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by Nords
Sometimes a house is just a home.
Agreed!!! Anything more than that is just "what if's?" in the financial sense.
  • What if I sell it
  • What if I keep it
  • What if I do a reverse mortgage
  • What if I bequeath it to the next generation
  • What if...

Remove the "what if's" and substute an "action". Until you do, it dosen't matter what your "plan" is, or how you view the "value" of a house. Plans change...

Anyway, a house, viewed as a "home" is more than that (it's priceless )

- Ron
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 06:12 PM   #31
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by Hydroman
Here is my 2 cents:

House equity is not a bond

That said, I believe house equity will allow you to significantly increase your equities allocation if you meet all the following conditions:


1) You have a fairly secure job or source of income to meet expenses.

2) You plan to sell the house and downsize to less expensive house in the future.

3) You are confident that the market value of your house will remain stable or increase from now until you plan to downsize.

4) You plan to allocate the liquid equity into real FI instruments after you sell the house and move/downsize into the cheaper house.

5) Your house is mortgage free (preferred but optional, depending on your personal sleep at night comfort level)

Note that these "conditions" represent risk that does not correspond to bond risks. Thus, a house represents an investment with a different risk-reward profile than a bond. Since the risk-reward relationship is the underlying principle that values all investments, the two are fundamentally very different and the differences should be understood.

A bond is a loan. Real estate is more like a business than a loan. With a bond an investor is loaning funds at a fixed rate and the entire principal is repaid at bond maturity. With real estate, both principle and income of the investment is subject to change based on market forces. There is no maturity date. Property owners also have to manage, repair, pay taxes, and insure their investment. Bonds are entirely passive investments.

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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 09:32 PM   #32
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Re: Advice....Should I look at home equity this way?

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Originally Posted by 3 Yrs to Go

Still seems like a fair interpretation.

You may disagree with what I consider to be the logical implications of using your house as a bond (i.e. potentially having to monetize it), but I don't think I put words in your mouth.

I'm also a bit curious how you rebalance your portfolio. Build a deck when times are good, sell a bedroom on the downturn.

A house is not a bond and I think it is a mistake to structure a portfolio assuming it is.
You picked some piece parts of what I said and created some implications. It seems you missed the part where I thoroughly explained the role the home equity plays in my financial planning. Nowhere did I say I planned to liquidate the property, just that it was an option. Nor do I see any reason to imply that liquidation is necessary or even suggested.

But do continue to ridicule what you apparently didnt read thoroughly enough to fully comprehend. The OP got what he needed and seems to have understood my input with no problems.
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 10:05 PM   #33
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Re: Advice....Should I look at home equity this way?

This may be a contrarian view. DW and I own our house mortgage free. We also own a bit of farm land (nearby, mortgage free and rented to BIL) and a condo in a hot market 500 miles away (DW lives in the mortgaged condo).

While both farm & condo rent for enough to handle expenses, we don't consider them (house, condo,farm) part of our assets when calculating a SWR since the return is near 0 and we are unlikely to sell them unless really destitute. Call us stupid but that's the way it is, at least for now.

Owning the house does lower our projected expenses though and we consider that.

Our view is that you have income producing assets and other assets making up your net worth. Only the income producing matter for RE income purposes. Would you RE with 10M in jewelry but no income?
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 11:05 PM   #34
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Re: Advice....Should I look at home equity this way?

Let me give an example to try and throw some light on the house is a bond arguement. For this example I will examine two households that have equal house values ($250k), equal net worths ($1050K) and equal lifestyles.

Household A has a 30 yr mortgage on their house of $200k @6% with P&I of $1193/mo and a portfolio of $1M from which they are taking a 4% SWR giving them $40K to cover all their expenses. Now it takes $14316 of the $40K to pay the P&I on the mortgage leaving them with $25684 for all their other expenses.

Household B does not have a mortgage on their house but only has an $800K portfolio. Now since their lifestyle is equal to Household A they only need $25684/yr for their expenses (plus worstcase $1779 for the additional tax bite due to not having an interest deduction) which is a SWR of 3.21% (or 3.43% with the extra for taxes). The question now is when running FIRECalc and you change the portfolio mix between (keeping the portfolio simple) stocks and bonds, raising the bond %age will lower the SWR thus the paid off house acts like a bond.

Note: I think another point CFB makes is that since Household B only needs a SWR that is lower than Household A they can choose to do either of two things in their portfolio 1) take on more portfolio risk than B by investing a greater %age of their portfolio in stocks or 2) go for a safer but lower yielding portfolio than B by investing a greater %age of their portfolio in bonds, where neither of these choices will be more risky to their lifestyle.
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 11:33 PM   #35
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by jdw_fire
Household A has a 30 yr mortgage on their house of $200k @6% with P&I of $1193/mo and a portfolio of $1M from which they are taking a 4% SWR giving them $40K to cover all their expenses. Now it takes $14316 of the $40K to pay the P&I on the mortgage leaving them with $25684 for all their other expenses.
I think most people would agree that the principal payment of the P&I is savings rather than an expense. You're paying yourself and saving the money as home equity.

It'd be nice if FC had a built-in amortization calc for the mortgage case, but if you're half-way through a mortgage, the split becomes about $500 principal and $700 interest, which gives you an SWR of 3.4% for the mortgage case (not considering the tax break).
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Re: Advice....Should I look at home equity this way?
Old 02-08-2007, 11:37 PM   #36
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by jdw_fire
Let me give an example to try and throw some light on the house is a bond arguement. For this example I will examine two households that have equal house values ($250k), equal net worths ($1050K) and equal lifestyles.

Household A has a 30 yr mortgage on their house of $200k @6% with P&I of $1193/mo and a portfolio of $1M from which they are taking a 4% SWR giving them $40K to cover all their expenses. Now it takes $14316 of the $40K to pay the P&I on the mortgage leaving them with $25684 for all their other expenses.

Household B does not have a mortgage on their house but only has an $800K portfolio. Now since their lifestyle is equal to Household A they only need $25684/yr for their expenses (plus worstcase $1779 for the additional tax bite due to not having an interest deduction) which is a SWR of 3.21% (or 3.43% with the extra for taxes). The question now is when running FIRECalc and you change the portfolio mix between (keeping the portfolio simple) stocks and bonds, raising the bond %age will lower the SWR thus the paid off house acts like a bond.

Note: I think another point CFB makes is that since Household B only needs a SWR that is lower than Household A they can choose to do either of two things in their portfolio 1) take on more portfolio risk than B by investing a greater %age of their portfolio in stocks or 2) go for a safer but lower yielding portfolio than B by investing a greater %age of their portfolio in bonds, where neither of these choices will be more risky to their lifestyle.
I ran these simulations back in the archives somewhere. Even if you treat your house as a bond (a very unjustified assumption) readjustment of the equity/bond allocation doesn not eliminate the historical advantage of keeping a mortgage for low enough interest loans and long enough time periods. In other circumstances, with higher interest rates, paying off the loan would have been advantageous.

If you payoff your mortgage, you have x% equity, y% bond, and z% home. Each of those assets is different with different risks and different potential for reward. If you keep your mortgage you have (x+delx)% equity, (y+dely)% bond, s$ home, and t% mortgage debt. Each of these assets is different with different risks and different potential reward. Owning a home is not without risk. Not all risk can be simply quantified using beta or other metrics that measure only market risk. Inflation risk, longevity risk, opportunity risk, etc. are not easily quantified and are different for each of the asset classes. In the case of a house, the risks are unique to the particular house and location you are in. Each investor has their own risk comfort level and depending on their situation some investors may have less longevity risk but more inflation risk(because of a significant pension, for example) than another.

So . . . the decision to payoff or keep a mortgage is a risk-reward decision. The risk portion of the equation is unique to each house and each investor. The only person who is wrong in these debates is the person who believes that a "one size fits all" decision is appropriate. Every case is different and only be evaluating your personal situation can you find the answer that is best for your house and your risk tolerance. Assuming a house to be the same as a bond neglects the fundamental risk-reward consideration that is the basis for all investment valuations. The "best" answer for you may be the same with or without this assumption, but it won't be like that for everyone.
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Re: Advice....Should I look at home equity this way?
Old 02-09-2007, 12:04 AM   #37
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by wab
I think most people would agree that the principal payment of the P&I is savings rather than an expense. You're paying yourself and saving the money as home equity.

It'd be nice if FC had a built-in amortization calc for the mortgage case, but if you're half-way through a mortgage, the split becomes about $500 principal and $700 interest, which gives you an SWR of 3.4% for the mortgage case (not considering the tax break).
Whether you consider the principle payment part of your P&I savings or not doesn't matter to my example as my example addresses cash flows. Since the two households in my example are retired they both require a certain level of cash flow from their portfolios to maintan their lifestyles. Even though part of that cash flow for Household A goes to a monthly principle payment it is still a required part of their WD so it counts toward their WD rate.

Quote:
Originally Posted by sgeeeee
So . . . the decision to payoff or keep a mortgage is a risk-reward decision.
I posted my example to show how a mortgage free house could be viewed as a bond in someone's portfolio not to make an argument for paying off a mortgage, which is a different topic.
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Re: Advice....Should I look at home equity this way?
Old 02-09-2007, 12:08 AM   #38
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Re: Advice....Should I look at home equity this way?

I guess your example just shows that not all cash flow is the same. If part of it flows back to me, do I really care if the withdrawal rate increases in the process? That type of flow is something you can always shutdown if it makes you nervous, but it seems very convoluted to let that equity build-up impact on the withdrawal rate change your investment criteria.
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Re: Advice....Should I look at home equity this way?
Old 02-09-2007, 12:44 AM   #39
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by jdw_fire
. . .
I posted my example to show how a mortgage free house could be viewed as a bond in someone's portfolio not to make an argument for paying off a mortgage, which is a different topic.
But if you view it that way, you shift the risk-reward balance of your portfolio in a way that does not recognize the distinction between a bond and a house. I included the mortgage aspect only because your example did.
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Re: Advice....Should I look at home equity this way?
Old 02-09-2007, 10:06 AM   #40
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Re: Advice....Should I look at home equity this way?

Quote:
Originally Posted by jdw_fire
The question now is when running FIRECalc and you change the portfolio mix between (keeping the portfolio simple) stocks and bonds, raising the bond %age will lower the SWR thus the paid off house acts like a bond.

Note: I think another point CFB makes is that since Household B only needs a SWR that is lower than Household A they can choose to do either of two things in their portfolio 1) take on more portfolio risk than B by investing a greater %age of their portfolio in stocks or 2) go for a safer but lower yielding portfolio than B by investing a greater %age of their portfolio in bonds, where neither of these choices will be more risky to their lifestyle.
Ding! Ding! Ding!

I see the problems. Everybodys stuck on the "HOUSE ISNT A BOND!!!!!" thing.

Its not a bond. Okay?

Now that we're past that hairball, can we move on from that to "HOME EQUITY CAN PERFORM A SIMILAR FUNCTION TO A BOND IN A PORTFOLIO"?

What you're doing in effect is removing a huge monthly cost which enables you to employ more flexibility in your portfolio...exactly as JDW describes.

In fact, you're foolproofing your retirement. In a "normal" scenario, should we have one of the two big failure situations - the depression and the 65-75 sideways period - you would be progressively eating your equities to pay the mortgage or have to go back to work to pay the mortgage.

In the other scenario without a mortgage payment, you could cut spending a bit, get by on dividends, worst case a part time job mowing laws, and leave your portfolio intact to bounce back once you're past the bear market.

Nowhere would I incorporate selling the house as part of a reasonable plan.

Setting aside the quackery around "rebalancing" by adding a porch or hacksawing off a room :, one can fine tune by adding or removing small amounts of bonds in addition to their home equity and stocks for diversification purposes.

Quote:
Originally Posted by sgeeeee
I ran these simulations back in the archives somewhere. Even if you treat your house as a bond (a very unjustified assumption) readjustment of the equity/bond allocation doesn not eliminate the historical advantage of keeping a mortgage for low enough interest loans and long enough time periods. In other circumstances, with higher interest rates, paying off the loan would have been advantageous.
Absolutely true. If you have a mortgage at about 5%, its a toss up. Once you pass below 4%, hell...I'd get a mortgage. In fact, when I had a shot at a 3.96% five year fixed in 2002, all y'all told me not to get it and invest the proceeds in stocks. Some prognosticators you guys turned out to be!

At the current rates and historical normal rates, the firecalc runs we tortured endlessly over the months and years established:

At mortgage rates of 5%+, by paying off your mortgage and reducing your bond holdings to move from a 50/50 or 60/40 to a 70/30 or 80/20, that you would make more money, have a higher SWR, a higher average terminal portfolio size and a higher survival percentage.

In other words, you could retire earlier, on less money, and have a better chance (against historical data) of "making it". Now come on, lets line up to find the "problem" in this opportunity... :P

In that scenario, the role of bonds is limited or non-existant. You simply dont need them, but are obviously most welcome to continue to hold some as a diversifier.

OF COURSE there are exceptions to this and lots of parameters. You need to run the numbers for yourself. Taxes are a big deal. In my personal scenario, by getting rid of the big withdrawal, the big payment, and tweaking a few other things, I end up paying almost nothing in income taxes.

I think a linchpin to it is looking at what percentage of your spending you could eliminate, and what percentage of your portfolio would be taken away to remove the home debt.

If your mortgage payment is 30-40% of your spending in retirement, and your portfolio would be reduced by 10-20% by paying off the mortgage...I'm betting you have a winner. If the mortgage is 20% of your spending and you'd cut your portfolio in half by paying the mortgage off...thats probably not going to be a good scenario.

In my case, I cut my spending by 35% and "suffered" a 15% drop in my portfolio. Went from a 50/50 to an ~80/20. My firecalc numbers went WAY up.

And I can tap that reserve at any time by writing a check on my free home equity line of credit. So much for the complications of liquidity... :

You are absolutely missing out on a huge thing if you dont run this calc and consider it. Of course, there are people who refuse to include their home in any planning, including net worth. If you have that hairball, just move along. Nothing to see here...
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Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.
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