Let's put some numbers to the eternal reciprocated diatribes on rent vs own & mortgage vs debt free.
I'm not claiming that ownership is always better than renting, or that mortgages are always better than debt-free. Those are personal choices and they probably should have a bigger emotional content than a cold-hearted bean-counting financial analysis-- especially if you have trouble sleeping at night.
But if you've been wondering whether you should pay off your mortgage early, then here's another perspective.
We signed the refinance papers today for a credit union 30-year 5.5% mortgage. We'll be making only the monthly payments and no additional principle so this one won't be paid off until the end of 2034 (when I'm 74).
The nicest thing about this refinance (our third) is that the mortgage payments are finally low enough to be covered by my pension with enough left over for property taxes, home/liability insurance, maintenance, and even utilities! Covering the home & mortgage with the pension takes all the uncertainty out of the math. The rest of our living expenses will be handled by <4% withdrawals from the remainder of the retirement portfolio. Spouse's wage income is certainly appreciated but not necessary.
The money that the credit union gave us is invested in the iShares S&P600/Barra Small-cap Value ETF (IJS). The ETF's expense ratio is 0.25%. 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.
With due regard for Bernstein's four-part <a href="
http://www.efficientfrontier.com/ef/998/hell.htm">
"Retirement Calculator from Hell"</a>, we plan to buy & forget with the presumption that past returns are prologue. <a href="
http://www.fireseeker.com/">FIRECalc</a> gives this scheme a 74.2% chance of making a profit. (The portfolio's initial draw is 6.81% but inflation is zero since the payments stay the same for 30 years.) If the portfolio survives the 1-in-4 catastrophe, its mean final value is over three times the mortgage's initial balance. (FIRECalc wants a 3.8% mortgage interest rate before it boosts the chance of success to 95%, but Bernstein claims that anything over 80% is meaningless.)
We're comfortable with a portfolio that's high in equities, so this shouldn't exceed our risk profile. But we'll keep an eye on long-term CD rates if we find ourselves tossing & turning at night. It'd be quite sweet to make a large deposit with the credit union and earn more in dividends than we pay in principle & interest. In our 15% tax bracket I guess that'd be >6.5%. (It's too bad that the Treasury no longer sells 30-year bonds.)
If you have a detailed retirement spending plan and if your retirement portfolio is adequately capitalized for a safe withdrawal rate, then a defined-benefits pension may be more than enough to pay off a low-interest-rate mortgage. For us the odds certainly outweigh the risk profile.
Threaded Mode
