Interesting Mortgage Article

[Katsmeow]

Interesting Article on whether to carry a mortgage in retirement:

http://crr.bc.edu/images/stories/Briefs/ib_9-15.pdf

The general analysis is that for most people it is better to pay of the mortgage.

They give the example of someone who has $100,000 in cash invested 50% each in stocks and bonds who has paid off their $200,000 mortgage.

Imagine this person still had a mortgage. They argue they would still only have $50,000 in stocks and $150,000 in bonds which the article contends is financially the same as having the mortgage.

They would contend this person doesn't want to have more stocks because if they really wanted to they could do that when they pay off their mortgage. That is they could have 75% in stocks ($75,000). Since they don't do that then presumably they wouldn't do it when they did have a mortgage.

The one situation where they imply it may be right to have a mortgage in retirement is when the funds to pay it are in tax advantaged accounts, you have a high marginal tax rate and itemize deductions, which combination they say is unusual. It is, however, the specific combination which I have....

 

[swampwiz]

Baloney! Presuming that the homeowner would have all of his cash in a retirement account, he would be able to shield that retirement account and only have the equity in the home (minus the homeowner's exemption) subject to liquidation in a bankruptcy (which would happen to anyone, e.g., if they would hit a city bus, etc., or be uninsured prior to the new health care system in 2014, etc.) If he paid off the home, then all that equity would be subject to liquidation. (NOTE: If the homeowner's exemption is greater than the value of the home, then paying it off would be OK - or alternatively, partially paying off the mortgage such that the equity would be less than then exemption would make sense as well.)

A good investor in equities should be able to stay even with the mortgage rate.

 

[travelover]

Baloney!........

So, what charm school did you go to?

 

[Katsmeow]

Baloney! Presuming that the homeowner would have all of his cash in a retirement account, he would be able to shield that retirement account and only have the equity in the home (minus the homeowner's exemption) subject to liquidation in a bankruptcy (which would happen to anyone, e.g., if they would hit a city bus, etc., or be uninsured prior to the new health care system in 2014, etc.) If he paid off the home, then all that equity would be subject to liquidation. (NOTE: If the homeowner's exemption is greater than the value of the home, then paying it off would be OK - or alternatively, partially paying off the mortgage such that the equity would be less than then exemption would make sense as well.)

You assume that exemption statutes are the same in every state and that a paid for homestead has less protection than a retirement account. That could be true in some states -- perhaps yours. It is not true in every state.

 

[Nords]

C'mon, guys, at least review the prior art on the subject before trying to patent a new dead-horse beater:
http://www.early-retirement.org/for...f-the-mortgage-or-invest-the-money-30644.html

including my personal favorite which I'll update in April,
http://www.early-retirement.org/for...rtgage-without-losing-your-ass-ets-15237.html

Swampwiz, before the moderators weigh in on your debating style, have you checked out Raddr's board? Your commentary reminds me of a few of their more prolific posters...

 

[Katsmeow]

I actually have read the threads on paying off the mortgage. I thought the article I posted was interesting and might be interesting to others. I did a search to see if it had been discussed before. If it has I was unable to find it.....

 

[haha]

I actually have read the threads on paying off the mortgage. I thought the article I posted was interesting and might be interesting to others. I did a search to see if it had been discussed before. If it has I was unable to find it.....

I think it was very interesting. Thanks for posting it.

Ha

 

[chinaco]

Thanks for posting the article.

I view the use of consumer credit to do shadow leverage as a bad idea... this includes homes, auto loans, and credit cards.

It is not even worth debating or even attempting to describe why. You will never convince someone who is doing it that it is a bad idea.

IMO on average it is a bad idea. There will be a few that will make out ok. Most will either lose or break even (because they are not great investors -- they are just riding the market wave).

 

[traineeinvestor]

Thanks for posting.

While borrowed money provides the opportunity to improve returns, it also carries the risk of lowering overall returns. I would have thought that once in retirement and lacking a pay cheque to fall back on, risk reduction would be more important than striving for higher returns. Put differently, if you need the extra return that leverage provides - can you really afford to retire?

 

[donheff]

Interesting article but I didn't buy their argument that someone who kept the mortgage would (or should) keep all of the funds that could have paid it off in bonds. I think most people would assign those extra funds in accordance with their preferred asset allocation which would tend to provide a higher expected return than 100% bonds. I know I did in the years prior to paying off my mortgages. The argument they use that you can match an increase in stocks in the no mortgage scenario just as easily as in the with a mortgage scenario by dollar for dollar increases completely ignores volatility. How many people would go $100K stocks (100%) in the no mortgage scenario? Lots of people would go $100K stocks (50%) in the keep the mortgage scenario.

 

[Danmar]

It was useful article-thanks. I think one of their points was that a mortgage is like a negative bond so if you want to keep your investing risk equal you will have to increase your fixed income proportion. I doubt most people would though instead they would increase their risk.

 

[ERD50]

Interesting article but I didn't buy their argument that someone who kept the mortgage would (or should) keep all of the funds that could have paid it off in bonds. I think most people would assign those extra funds in accordance with their preferred asset allocation which would tend to provide a higher expected return than 100% bonds....

+1.

And to be consistent with the 'replace the mortgage with bonds', they should be telling anyone with a mortgage to stay 100% in bonds until they pay off the mortgage. Would that really be a good recc for someone in their earlier stages? To go for many years without any stocks until you can save enough to pay off the mortgage? Keep your 401K in bonds all those years?I'm glad I didn't do that!

-ERD50

 

[Katsmeow]

+1.

And to be consistent with the 'replace the mortgage with bonds', they should be telling anyone with a mortgage to stay 100% in bonds until they pay off the mortgage. Would that really be a good recc for someone in their earlier stages? To go for many years without any stocks until you can save enough to pay off the mortgage? Keep your 401K in bonds all those years?I'm glad I didn't do that!

-ERD50

I didn't think they would say that you have to be 100% in bonds if you have a mortgage. What they seem to be saying is that to maintain the same risk-return portfolio with a mortgage as without that you keep 100% of the amount of the mortgage in bonds. The amount of your portfolio that is greater than the mortgage could be part in stocks. The example they give is someone who pays off their $100k mortgage and still has a $100k portfolio who would then have $50k in stocks and $50k in bonds. Before they paid off the mortgage, they argue that to be consistent and maintain the same risk/return portfolio would have $50k in stock and $150k in bonds.

 

[Nords]

I didn't think they would say that you have to be 100% in bonds if you have a mortgage. What they seem to be saying is that to maintain the same risk-return portfolio with a mortgage as without that you keep 100% of the amount of the mortgage in bonds. The amount of your portfolio that is greater than the mortgage could be part in stocks.

The challenge is making sure that everything else in the portfolio has a higher return (over the lifetime of the mortgage) than the mortgage itself. Otherwise it's just wasting money.

When we refi'd to 30 years fixed at 3.625% it never occurred to me to look for a 30-year Treasury (or any other 30-year bond) with a higher yield. I assumed I'd only find that from holding equities.

 

[rayvt]

Man, I thought I got a deal-of-a-lifetime when we refi'ed at 4.00% (30 yr fixed) last month. But that was with zero points. So maybe you paid 1-2 points to get that 3.625?

Frankly, I can't imagine a scenario where a reasonable portfolio won't return more than 4% over the next 30 years. Actually, I can--but those are "Red Dawn" scenarios. And if that comes to pass, a mortgage will be the least of my worries.

 

[Katsmeow]

Frankly, I can't imagine a scenario where a reasonable portfolio won't return more than 4% over the next 30 years. Actually, I can--but those are "Red Dawn" scenarios. And if that comes to pass, a mortgage will be the least of my worries.

As I understand the thesis of the article, it is that a risk free investment won't return significantly more than a mortgage.

Of course, I've no doubt a portfolio with risk could return more than 4%.

The argument that they make in the article is that the person who has a mortgage won't invest in a more risky portfolio because that person could do that while having a mortgage. That is the person who has $100,000 and is 50% in equities, 50% in bonds with no mortgage could simply buy 100% equities and get a higher return with no mortgage. An alternative might be to have a $100,000 mortgage and then invest $100,000 in equities (still 50%) and $100,000 in bonds (still 50%). But the person could achieve the same amount in equities by having no mortgage and putting 100% in equities. Therefore, the article assumes that the person who has a mortgage will invest in bonds the funds freed up by having a mortgage.

Therefore, the article sort of looks at paying off the mortgage as sort of like investing in bonds.

Now, as a practical matter I think the article is just wrong about human nature and how people invest in that situation.

 

[rayvt]

Therefore, the article sort of looks at paying off the mortgage as sort of like investing in bonds.

That's the same fallacy as the assertion that paying extra principal is equivalent to getting a "guaranteed return" at the same rate as the mortgage. It isn't. Paying off/down a mortgage eliminates an expense. Making a return (in bonds) means that somebody sends you a check periodically. These are not the same thing at all. Not even sort of like the same thing.

 

[ERD50]

As I understand the thesis of the article, it is that a risk free investment won't return significantly more than a mortgage.

Of course, I've no doubt a portfolio with risk could return more than 4%.

The argument that they make in the article is that the person who has a mortgage won't invest in a more risky portfolio because that person could do that while having a mortgage. That is the person who has $100,000 and is 50% in equities, 50% in bonds with no mortgage could simply buy 100% equities and get a higher return with no mortgage. An alternative might be to have a $100,000 mortgage and then invest $100,000 in equities (still 50%) and $100,000 in bonds (still 50%). But the person could achieve the same amount in equities by having no mortgage and putting 100% in equities. Therefore, the article assumes that the person who has a mortgage will invest in bonds the funds freed up by having a mortgage.

Therefore, the article sort of looks at paying off the mortgage as sort of like investing in bonds.

Now, as a practical matter I think the article is just wrong about human nature and how people invest in that situation.

And the problem you could see with the paid off house and moving the $100K to 100% EQ is liquidity. Imagine a bad stretch where EQ drop to 50% value and Bonds drop to 90% value. The person with paid-off house sees their 100K in EQ drop to $50K.

The person with a $100K mortgage invested 50-50 would have $140K ($50K EQ and $90K Bonds). Sure, they have to pay the mortgage out of that $140K, but they experienced a 30% drop in their investments, while the paid-off person would see a 50% drop.

They both experience the same rise/drop in their home price, if that's important.


On your last comment regarding human nature, I agree. I suspect that most people who are eager to pay off a house are not the same people who would go to a large % in EQ.

-ERD50

 

[Nords]

Man, I thought I got a deal-of-a-lifetime when we refi'ed at 4.00% (30 yr fixed) last month. But that was with zero points. So maybe you paid 1-2 points to get that 3.625?
Frankly, I can't imagine a scenario where a reasonable portfolio won't return more than 4% over the next 30 years. Actually, I can--but those are "Red Dawn" scenarios. And if that comes to pass, a mortgage will be the least of my worries.

2.125 to be precise. We got an eighth knocked off for having over-800 credit scores and a low loan-to-value ratio. So the payback on this refi is about four years.

I think we'll make a profit over the next 30 years, but the APY volatility over the last six years has been impressive.

http://www.early-retirement.org/for...rtgage-without-losing-your-ass-ets-15237.html

 

[HFWR]

So, what charm school did you go to?

In charm school, we say "bologna"....

 

[JustCurious]

If he paid off the home, then all that equity would be subject to liquidation.

Not necessarily true, it depends on your state. For example, in Florida, all of the home equity would be exempt from bankruptcy.

 

[nun]

The article reinforces my philosophy of being debt free going into retirement. I want to minimize my need for income and thus reduce my tax bill when I come to take money out of my retirement accounts. However, I'd never take a lump sum out of a retirement account to pay off my mortgage as I wouldn't want the tax bill. I'm still working so each month I make extra principal payments and I'll pay it off with after tax money when it won't cause a liquidity problem. I could do it right now, but it would eat into my after tax funds too much. Going into ER I want to be debt free (ie Debt Free, Early Retirement, or DFER (duffer), I'm trying to polularize this acronym), but after tax liquidity is also important even with the 72t tool.

 

[ERD50]

The article reinforces my philosophy of being debt free going into retirement. I want to minimize my need for income and thus reduce my tax bill when I come to take money out of my retirement accounts. However, I'd never take a lump sum out of a retirement account to pay off my mortgage as I wouldn't want the tax bill. I'm still working so each month I make extra principal payments and I'll pay it off with after tax money when it won't cause a liquidity problem.

Isn't this a wash?

If you have after tax money to pre-pay the mortgage now, couldn't you use that to pay the mortgage in retirement? And if you are in a lower bracket in retirement (not a given), it would seem better to stretch the payments out over that time.

One long time poster would go on about reducing your tax burden by not needing this mortgage payment cash flow. I don't think he could ever explain where you get the money to pre-pay it.

-ERD50

 

[SunsetSail]

he would be able to shield that retirement account and only have the equity in the home (minus the homeowner's exemption) subject to liquidation in a bankruptcy.

Not necessarily true, it depends on your state. For example, in Florida, all of the home equity would be exempt from bankruptcy.

I'll second JustCurious' post but generalize that the first statement is an oversimplification to the complex and gray area of asset protection. Retirement accounts generally afford more protection from creditors than non-retirement accounts, but to assume they are always safe from creditors is dangerous.

 

[veremchuka]

thanks for posting this article's link.

when you are working i think having a mortgage is a good thing since you most likely can't afford to pay off the mortgage and instead you can put as much money aside for retirement as you want. over 20 or 30 years you'll pay off the mortgage, typically have a tax benefit and watch your investments grow.

in retirement i think having a mortgage is not in your favor. reducing expenses is more important since you are now living off your investments and a pension if you have one, ss too. also ss can get messy cuz the more you need from investments (as in mortgage payments) it can push you into a higher tax bracket potentially.

my mortgage was just 5 1/4% and i paid no points but 7 years into the mortgage and 3 in retirement made me reconsider keeping the mortgage for another 23 years. interest was $6500 a year and while i was fully able to itemize it all it required taking cash from taxable savings every month to pay monthly expenses. as a saver/lbym this killed me, of course taking the money from the same place to pay it off seriously depleted cash but i have no mortgage and i am able to save almost $10k a year, in a year or 2 i'll be fine on cash. paying the mortgage off with tax deferred investments would not be wise imo unless you had a small balance, did it over a few years and were able to not jump into higher tax brackets.

i suppose that in the end each person must decide what is best for them. don't tell ric edelman about this paper, he thinks everyone needs a big mortgage so they can invest with edelman financial... even in retirement (once heard him tell a 75 year old to get a 30 year mortgage!).