Covering a mortgage without losing your ass(ets).

[LEX]

I do not buy my clothing with the idea that I have made "an investment", same with my car, and in fact I treat my house as only a consumable expense. In all these classes of "asset" I pay cash or move towards payoff as soon as i can. Owning these mainstays for basic living is a fundamental risk hedge when ones cash flow can not be easily incresed, such as one retired on a fixed income. Playing with debt as if one can arb the banking system can work, especially in an inflationary economy, where interest rates will rise above the basis of the bank loan, or one that has a currency that will move down in real value, such as the recent situation in Argentina.

For me, I choose to treat my house as a form of prepaid rental annuity, where my pay off was a prepayment of future rental costs, minus tax, insurance and maintenance overhead, which are significantly lower than debt burden for capital replacement of the house. I would rather not do anything to leverage this annuitized position with a mortgage and interject foreclosure risk at this point in my financial planning cycle.

 

[sgeeeee]

I do not buy my clothing with the idea that I have made "an investment", same with my car, and in fact I treat my house as only a consumable expense.  . . . 

Well . . . whatever you feel good about is okay for you. But I don't see any similarity at all between the financial implications of borrowing for a home and borrowing for my socks and underware.

I don't expect my clothing to last for 30 years so a 30 year loan doesn't make much sense for socks and underware. And if the right time frame for my socks and underware were only 3 or 4 years, then I might have trouble finding any interest rate loan (short of 0%) that I would feel good about. Also, the DW and I spend less than $1000 per year on clothing. Even if I could make money on the loan it would be insignificant and doubtless not worth the effort.

My car is only slightly different. I tend to keep a car for 6 to 10 years depending on mileage, etc. Even at 10 years, a loan rate would have to be pretty low to insure a high probability of financial gain and the amount of money involved is still pretty insignificant. I suppose if I could get a 1% or 2%, 10 year loan for my cars, I would consider it. But there is still more risk for that kind of purchase than there is for a 30 year mortgage on a home at 5%.

Also, I don't see much leverage in financing a depreciating investment like my Fruit of the Looms or Dodge Ram. But my home keeps going up in value and I'm getting that increase in net worth without having to committ current dollars.

Everyone should do what they feel comfortable with. But my view of things is that my home is not at all like my underware.

But I'm making real money on my low interest home mortgage.

 

[Nords]

But I'm making real money on my low interest home mortgage. 

As long as you don't splurge on socks & underwear...

 

[HFWR]

Don't wear either.............

 

[Nords]

Don't wear either............. 

It's good to know that you can always count on someone to explain the subtle jokes to the rest of the audience...

 

[LEX]

But I'm making real money on my low interest home mortgage. 

...and your bank has a call to own your property outright under a very one sided deed of trust which the mortagee has over this primary asset that even california with its consumer friendly courts will yank the house right from your widows feet with the right set of circumstances. It always amazes me that so many of us are so smart that we must play with our money for a few points spread. I suggest that if you pay off the house and leave leave things simple you have taken care of one of the most difficult estate issues that can arise for your surviving spouse. She has a roof over her head and will not have the mortage to worry about.

I can and continue to make plenty of income on arb spreads in the copper and oil markets, both in equity and pure commodity trades. Its fun, and i am a seasoned professional. Perhaps because I have seen both short, margin and secured positions go bad and leave one totally broke, I refuse to do the same with the home my family lives in.

So, make your trades and good luck.

 

[sgeeeee]

...and your bank has a call to own your property outright under a very one sided deed of trust which the mortagee has over this primary asset that even california with its consumer friendly courts will yank the house right from your widows feet with the right set of circumstances.  It always amazes me that so many of us are so smart that we must play with our money for a few points spread.  I suggest that if you pay off the house  and leave leave things simple you have taken care of one of the most difficult estate issues that can arise for your surviving spouse.  She has a roof over her head and will not have the mortage to worry about.

To me, this is a fear based, irrational argument. I have the money to pay off the mortgage tomorrow -- 25 times over. I'm in no danger of losing my house. That's absurd. If I did pay off the mortgage, I would have less nest egg. A lot of folks seem to miss that point. When you pay off the mortgage, you have less money working for you. And a house is far less liquid and versatile than money. Historical simulators don't lie about history. Throughout the 1872 to modern financial history, the safest financial move to make regarding a 5% 30 year mortgage is to keep it. That is a simple fact. People think they are being safe and conservative paying off their mortgage, but if their rate is low enough and the term is long enough they take on more risk by paying it off than by keeping it. If they feel better paying it off, then by all means they should do it. But they aren't tilting their odds toward safety.

I can and continue to make plenty of income on arb spreads in the copper and oil markets, both in equity and pure commodity trades.  Its fun, and i am a seasoned professional. Perhaps because I have seen both short, margin and secured positions go bad and leave one totally broke, I refuse to do the same with the home my family lives in.

If that feels good to you, that's great. I personally don't like the risks of trying to make money on spreads in copper and oil markets. I don't feel comfortable with commodity trading and I wouldn't find it fun. That's too much risk for my blood. I'm a simple index investor with a smattering of individual bonds and stocks that I am very familiar with. But I do understand how to make money by making my normal balanced investments and making periodic fixed payments on my mortgage. I can measure how much money I am ahead at any time (thanks to Microsoft Money). The odds are heavily in my favor and I am way ahead in this investment choice.

But your confidence in your own investment prowess really makes me wonder -- if it is easy and safe for you to make plenty of money trading in this way, why would you pay off a low interest mortgage rather than use that money to build more comfort and safety for your family? What is your rate of return over the past 3 or 4 years? If it's better than ~6%, you could have been making a lot of money on the spread between your return and the mortgage(w/tax) rate.

So, make your trades and good luck.

I will. Thanks. And good luck to you too.

 

[LEX]

I leave you with the last word on topic....good discussion.

 

[Nords]

Re: Ass(ets) redux.

Back in Oct 2004 (the beginning of this thread) we moved a large chunk of our portfolio, including the refinancing proceeds, into the S&P600/Barra Small-cap Value ETF (IJS). I'm tracking this on a spreadsheet with the assumption that we subtract 15% from dividends (to pay taxes) and reinvest the remainder (which Fidelity brokerage does for free). The ETF is up 18% since then and reinvesting dividends has boosted the return to 18.7%. Sure it looks smart now, but let's give this another 29 years before making a judgment call. We could look equally stupid next spring but we'll keep reinvesting those after-tax dividends.

Annual update: The latest quarterly dividend was just paid and we're up 31% after-tax over two years or about 14.5% APY. I'm assuming that dividends are taxed at the 15% rate and reinvested.

I'd be surprised to see any further gains over the next year or two. IJS has been bumping up against its 52-week high several times this year and the demise of small-cap investing has been widely forecast for at least three years.

And of course this experiment is running for another 28 years, of which several could be quite a bumpy ride... but it's good to start up instead of down.

 

[Nords]

At Drip Guy's question, here's an update. Three months is meaningless in the context of a 30-year mortgage but this might really really be the top.

IJS paid out a little over 24 cents/share last week and we're now up a total of 40% over 27 months. That looks like about 16% APY even after paying taxes at the 15% rate and reinvesting, although I'm not sure how much of that payout was cap gains.

IJS is up another 8% since I accused it of peaking.

 

[DRiP Guy]

At Drip Guy's question, here's an update. Three months is meaningless in the context of a 30-year mortgage but this might really really be the top.

IJS paid out a little over 24 cents/share last week and we're now up a total of 40% over 27 months. That looks like about 16% APY even after paying taxes at the 15% rate and reinvesting, although I'm not sure how much of that payout was cap gains.

IJS is up another 8% since I accused it of peaking.

Thanks! And also thanks for answering on this thread, which is where I should have asked, since you mentioned the other thread was not for that topic.

 

[rs0460a]

My - what a thread!

I'm glad I'm "old" and my/DW's mortgage (actually note) days are behind us .

- Ron

 

[magellan_nh]

I leave you with the last word on topic....good discussion.

I'm with LEX on this one. While it might make financial sense to margin your house and invest the proceeds, it has to be called what it is - leveraged investing. Because of the government subsidy on mortgage interest payments and the low borrowing costs, the economics have been favorable in the past. The question is whether the risks are priced correctly and whether you're retirement plan is able to handle a two or three sigma market event.

I actually like LEX'es way of thinking about the house purchase as a way to mitigate retirement risk by making retirement housing costs more of a known quantity. I've wished I could do this same thing with property taxes ($13k per year and rising) and with healthcare costs ($7k per year and rising), but I can't find anyone to take the other end of that deal.

Jim

 

[kcowan]

The other aspect to this is asset diversification. If you home has appreciated singificantly, it may not continue forever, so borrowing to invest can make sense for diversification to other asset categories.

Of course, the fallback plan would have to include downsizing if the other categories fail to outperform the mortgage after taxes.

 

[brewer12345]

What seems to be missing in this discussion is that leverage applies to aportfolio, not just to the incremental assets purchased with leverage (unless the loan is non-recourse). It isn't whether the incremental assets beat the cost of the money, it is whether the bulked up portfolio beats the cost of the money.

 

[free4now]

This was a good thread to read. My new years resolution is to sell my condo a half hour outside San Francisco, and start renting in San Francisco proper.

I never make economic moves solely for market timing reasons, but when I have other reasons to buy or sell I will pay attention to market timing. Never in my life have I seen so much agreement that the real estate market is not going to appreciate in the next few years. If I had a strong reason to stay where I am, maybe I could justify staying in my condo, but I'm pretty sure I'm going to want to move sometime, and now seems to be the right time.

Given that the value of my condo is about half my net worth, the only way to justify it is to count on appreciation. Since it is very unlikely that we will see significant appreciation in the next few years, and since I'm pretty sure I'm going to want to move in the next few years, it seems time to sell. I considered renting it out for a while, but that seems like more of a "buying time" move, not a sustainable financial strategy.

I'm still young (mid-30's), so I'm willing to pay the premium rents to live in a world-class city. Otherwise I would be moving out to the hinterlands.

Maybe I'll run into OAP in SF

 

[Lagniappe]

This was a good thread to read. My new years resolution is to sell my condo a half hour outside San Francisco, and start renting in San Francisco proper.
...willing to pay the premium rents to live in a world-class city. Otherwise I would be moving out to the hinterlands.

Maybe I'll run into OAP in SF

Free4now,

My resolution is to sell my condo in the city of SF, and move about 30 minutes outside the city (not sure yet if I'll rent or buy). Given the generally good public transportation, why move into the city and pay double the rent? Just curious...

TV

 

[kcowan]

What seems to be missing in this discussion is that leverage applies to aportfolio, not just to the incremental assets purchased with leverage (unless the loan is non-recourse). It isn't whether the incremental assets beat the cost of the money, it is whether the bulked up portfolio beats the cost of the money.

I agree in general but initially it is useful to look at the incremental returns, if any. Because if moving to leverage reduces overall returns, at least you need to question your asset selection criteria.

This is similar to product pricing. If you adopt a marginal contribution model, you are driving the company toward zero profit margin by not covering the overheads.

 

[LEX]

Hey, free4now,

Tune in to

http://patrick.net/wp/

You are both on the same thesis which is to cash out of the hyper inflated bay area market now, rent, and enjoy the cheap oppurtunity after the bubble bursts!

You have figured this one out!

 

[JustCurious]

Nords, you excluded (1) closing costs, (2) trading costs, (3) taxes. So your results are flawed. Not to mention that "past performance does not guarantee future results."

 

[Nords]

Nords, you excluded (1) closing costs, (2) trading costs, (3) taxes. So your results are flawed. Not to mention that "past performance does not guarantee future results."

Ye gods, man, are you sure that you read the whole thread? Here, wait, I'll get the relevant parts of it for you:

Dividends (~1%) & cap gains (if any) will be reinvested free of charge. The closing price on 8 October 2004 was $110.06.

Since closing costs will be recouped by the lower payments in just eight months, I'm not going to count that against the returns. The Fidelity brokerage fee is minimal (one really big trade in a frequently-traded account) so I'm not counting that either.

We refinanced again this month-- barely nine months after the last refinance (which has already paid for itself). This time we went from NFCU's 5.5% to 5.375%. Zero points, less than 80% LTV, no cash out, applying online, no documentation or appraisal, and haggling with the title company brought the total refinancing cost down to $1151. Our payments dropped by $44 so this time it'll take 27 months to pay back the refinancing costs.

Back in Oct 2004 (the beginning of this thread) we moved a large chunk of our portfolio, including the refinancing proceeds, into the S&P600/Barra Small-cap Value ETF (IJS). I'm tracking this on a spreadsheet with the assumption that we subtract 15% from dividends (to pay taxes) and reinvest the remainder (which Fidelity brokerage does for free). The ETF is up 18% since then and reinvesting dividends has boosted the return to 18.7%. Sure it looks smart now, but let's give this another 29 years before making a judgment call. We could look equally stupid next spring but we'll keep reinvesting those after-tax dividends.

Annual update: The latest quarterly dividend was just paid and we're up 31% after-tax over two years or about 14.5% APY. I'm assuming that dividends are taxed at the 15% rate and reinvested.

At Drip Guy's question, here's an update. Three months is meaningless in the context of a 30-year mortgage but this might really really be the top.

IJS paid out a little over 24 cents/share last week and we're now up a total of 40% over 27 months. That looks like about 16% APY even after paying taxes at the 15% rate and reinvesting, although I'm not sure how much of that payout was cap gains.

And I'll recap:

Nords, you excluded (1) closing costs

The lower mortgage payments have more than taken care of the closing costs. I'll also point out that the total sum of all the closing costs we've paid (getting the loan and then refinancing it) are less than 1% of the loan a couple percent of the profits. Hawaii mortgages are pretty hefty and we haggled hard on the closing costs.

(2) trading costs,

So far that's a Fidelity commission of three $8 trades. We could've done it one trade but I suspect that the share volume would've driven up the price. Since we paid that commission (Oct 2004) all dividends have been reinvested for free.

(3) taxes.

Well, so far I've been paying the taxes out of other funds, as I suspect that anyone else would do in the real world. I'm not going to liquidate shares for an $8 commission to pay a few hundred in taxes. But I've tracked the numbers on a spreadsheet, and on that spreadsheet I've been paying tax on the dividends at what I feel is an extremely conservative 15% rate before reinvesting them. The returns I've quoted in this thread are after-tax returns. If dividend tax rates change then I'll change the spreadsheet.

So your results are flawed.

Yes, and extremely profitable. I suspect that the "flaws" don't invalidate the two points that have been made so far:
- mortgage arbitrage can be profitable, and
- a bigger ER portfolio is more survivable.

Of course we'll know the full results in another 28 years.

Not to mention that "past performance does not guarantee future results."

You're absolutely right. The best data I could find was Dimson & Marsh's study on a century of investment returns claiming that there's a small-cap value premium. I feel that conclusion has been adequately validated by Bernstein and others. Of course the next couple decades could prove that past is no longer prologue, but I'm going with the best information available.

When you have a better system then I'd be happy to use it.

 

[free4now]

My resolution is to sell my condo in the city of SF, and move about 30 minutes outside the city (not sure yet if I'll rent or buy). Given the generally good public transportation, why move into the city and pay double the rent? Just curious...

Well the main reason is to get it out of my system. All my life I've lived just outside big cities and have always had fantasies of actually living in the city itself. I find that living in an isolated condo out in the burbs just isn't stimulating enough for me.

The other way I look at it is that living in a city as a FIREd person with time on my hands is actually a great way to efficiently consume the cultural resources the city provides Most people who live in cities pay the high rents just to be able to enjoy the city for a couple of hours a week in their free time. But as a FIRE'd person I can reap the benefits of living in a city hours every day, without having to put up with the commute hassles that plague workers.

Last but not least, one reason for moving to the city is dating. Where I currently live on the edge of Silicon Valley, it seems most of the women are looking for and finding the spendy breadwinners (not me). The interesting women to me have always been in San Francisco (and Berkeley). In my experience women in the city can't be bothered to make the drive to date someone outside the city.

 

[Nords]

Update after December's dividends:

Still up 27% after the dividend (at a share price of $67.80).

At 39 months, with a share price of $64, up a bit over 20%. That's an annualized after-tax return of 6% on a 5.375% mortgage.

NFCU's zero-points zero-origination-fee 30-year fixed mortgage appeared to bottom out at 5.5% (it's back up to 5.625%). We probably won't see 5.25% but the year is young...

 

[liveitup]

I'm a big fan of paying off a mortgage asap.I paid off my first home in 8 years and have no regrets in doing so.

Several years ago,I purchased a home with a mortgage payment of $920 per month @ 5.5%. $743 is interest $177 is principal.

IN MY MIND by making an extra principal payment of $177,I'll get a $743 return on my investment.That's over a 400% return in one month!

That return will come down over as more money is allocated to principal an less toward interest.

I will use a HELOC occasionally to purchase investment property,but I always try to pay if off ASAP.

 

[cute fuzzy bunny]

Nords -

Your strategies and backups ARE a little different from the way most folks would go about it...

A 100% or nearly 100% allocation to equities, a cola adjusted income, and the professed set of brass ones to ride that out through a multiyear bear market can definitely produce a larger, more survivable portfolio and a higher income level.

With the knobs turned to 11, the more you put in one side, the more comes out the other.

Where it gets dicey is when its done the way almost everyone else does it. Carry a higher spending load from the mortgage. Set the asset allocation around 60/40 so the equity volatility doesnt scare the pants of you when its time to make the monthly bill payments. Then set aside 3, 5 or 7 years of cash "just in case".

Once you factor in the return drawdown of the higher bond load and the cash thats losing value to inflation, the arb upside is pretty limited.

In fact, the Firecalc runs I did showed that someone with a paid off mortgage, the smaller portfolio, and an 80/20 allocation would easily run down someone with a mortgage, the commensurately larger portfolio and a 60/35/5 portfolio.

Much better survivability, far fewer "near deaths" due to low balances that came back at the last minute, and much higher terminal portfolio sizes on the no debt version.

So sure, you take a high equity load, get a rate around 5%, and can stare down a long bear with a vulcanlike steely eyed gaze...then you can arb a gain out of the equation. No brainer.

Spending risk, portfolio risk, rates of return, success rates, terminal portfolio sizes...seems to me that the best bet is to find out how to minimize as many of them as possible and still have a certain good outcome.