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Mortgage in ER or "Inflation coming?"
Old 09-23-2014, 09:04 AM   #1
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Mortgage in ER or "Inflation coming?"

Should pay off the mortgage shortly. Will be right around starting ER. Mentally, it is a big thing. We always paid more than the minimum, took out 15 or 20 year loans instead of 30, bought less house than they said we could afford, etc.

I am progressing with plans for a workshop. Due to the neighborhood (and actually for our desires and long term value as well) the shop will be the shell of a normal house so it can be converted easily at some point. Building materials are going up in cost much faster than the official CPI. Building labor for those parts I can't do myself are rising as well.

Mortgage rates are very low. Our interest payments are now small enough that we take standard deduction instead of itemizing.

I personally think interest rates/inflation have to shoot up substantially at some point. Certainly in the next 3-5 years.

So.... While it goes against everything I anticipated, I am looking very hard at taking out a new home loan going into retirement. Payments would be same as current. On paper it looks like it would actually be profitable if inflation increases to just 5% within 5 years and stocks keep pace. At inflation rates of 3% I'm really only out the points/fees for the loan. The loan will be excess to what I need for the shop so the excess would either go to mutual funds/CDs (if I can find a good rate!)/another rental property or just pay off a chunk of mortgage when the shop is complete.

Thoughts?...
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Old 09-23-2014, 09:11 AM   #2
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I'm not sure how you are calculating the "profit" when you say the loan would be "profitable".

I think you're making an assumption that your income will go up with inflation, maybe you have a COLA'd pension, or you have investments that you believe will do better in a high inflation future.
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Old 09-23-2014, 09:28 AM   #3
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You are correct, thank you. "Profitable" is probably a bad term here. If you purchase materials with borrowed money for an effective rate lower than the rate of inflation your costs are actually lower than saving the money and buying later. I would not be making money. I would be getting the materials and labor at a discount and getting the shop earlier but I would still be spending money since the shop is not a money making operation. This is a riskier version of buying the materials with a zero percent credit card and putting the cash for the purchases into a CD. Done that before and the payoff is guaranteed. This is for bigger amounts, longer terms, and the payoff (other than getting the shop early) is only if the inflation rate increases and investments keep pace. Its the "ifs" that bother me in that I've spent most of my life eliminating them where possible.
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Old 09-23-2014, 09:29 AM   #4
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Actually, that would be an interesting number to run--what would inflation/investment return have to be to make it actually "profitable" as in get the shop for free and still make money? I hope we never get there!
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Old 09-23-2014, 09:43 AM   #5
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The bond market gives us its best guess at inflation:
implied inflation = nominal bond - TIPS bond

Currently for the 10 year Treasury:
implied inflation = 2.55 - 0.54 = 2.01%
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Old 09-23-2014, 11:48 AM   #6
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Isn't this a bit like paying cash for a car vs taking a low interest loan, knowing you can likely make 2X the interest in the market on that money.
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Old 09-23-2014, 01:14 PM   #7
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According to Wes Moss, part of the decision process includes how much after tax money you have available.

If you can do what you want to without spending more than 1/3 of your after tax money, then you should pay cash. Otherwise, hang on to your after tax money and use a loan.

I think the idea is that if you spend too much of your after tax money, that reduces flexibility. You could paint yourself into a corner where you'd need to pull from your IRA or 401k in amounts and at times that are not advantageous.
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Old 09-23-2014, 01:35 PM   #8
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Thats not a bad rule. Things like this are more complex though--

If you manage your own construction, you have a lot of leeway on when you do certain expenditures and can usually trade labor for $$$. As a bad example--spend a week digging the footings with pick and shovel. Hire day laborers for minimum wage to do it. Rent a backhoe and do it in a day.
Further in I'll have even more flexibility--given that its a shop space, the interior construction can be spread over years.

Really the only stages that have to be done on a timeline are digging footings-pouring cement and framing-roofing. These can't stretch too long or you have issues with weather damaging material and undoing your work in progress.

Well, there may be another time restraint--never had to worry about the building permit expiring. I don't know how long I have from taking that out to getting it signed off.

Going slowly allows me to do it cheaper in a lot of cases but it can be more inefficient. Who wants to keep an empty shell for a year just so you don't have to move everything out to do the interior walls? Working around a bunch of materials in the shop space would make doing the interior much more time consuming as well. So, borrowing money and doing it in one whack helps alleviate that. If you are paying for the labor, that can save money. If you are doing it yourself, its a question of what you value your time at and how much money do you have to spend.
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Old 09-23-2014, 01:38 PM   #9
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Isn't this a bit like paying cash for a car vs taking a low interest loan, knowing you can likely make 2X the interest in the market on that money.
Very much. Two things to think about in this case though-- would you take out a mortgage to invest in stocks, bonds, or CDs? I don't HAVE to buy a new shop (or car) so I could just spend $0.
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Old 09-23-2014, 01:39 PM   #10
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I'm happy to carry my recently refinanced 30 year 3.25% mortgage into retirement. Inflation is one reason, I might pay it back with cheaper dollars, but mostly I expect to make more than 3.25% with my portfolio.
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Old 09-23-2014, 02:51 PM   #11
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I'm happy to carry my recently refinanced 30 year 3.25% mortgage into retirement. Inflation is one reason, I might pay it back with cheaper dollars, but mostly I expect to make more than 3.25% with my portfolio.
I chose to do the same with my 3.5% fixed 30 year loan. I am mostly doing this as inflation protection.
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Old 09-23-2014, 03:09 PM   #12
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Originally Posted by brewer12345 View Post
I chose to do the same with my 3.5% fixed 30 year loan. I am mostly doing this as inflation protection.
Current ER plan includes carrying our mortagage through into retirement at 2.75%. That said, I don't think we'll stay in the same home for the next 40 years. We might not even be in the same place in 5 years... either way, spending plan accounts for a mortgage payment or rent without problem, and if we do stick it out with one mortgage, I view it as an effective use of leverage.
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Old 09-23-2014, 05:11 PM   #13
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Very much. Two things to think about in this case though-- would you take out a mortgage to invest in stocks, bonds, or CDs? I don't HAVE to buy a new shop (or car) so I could just spend $0.
Okay, I think I'm understanding this a little more.

One possibility is that you're comparing
A) Build now with borrowed money, vs.
B) Build later

In (A), you're committing to pay a fixed rate, but thinking that rate will be lower than inflation in construction materials/labor, so in the long run you will pay fewer dollars out of pocket with A than B. This seems like a case of comparing the interest rate in A vs. the inflation rate in B, recognizing that one is fixed and the other is floating.

However, I'd add in the costs of having the building sooner - may taxes and depreciation. But then you may get some utility from the building by building it sooner, like you actually use it for a shop.

Another possibility is that you're comparing
A) Build now with borrowed money, vs.
C) Build now with funds withdrawn from your investments.

In this case, you're comparing the interest in A vs the future investment earnings lost in C. Again, one is fixed and the other is (probably) floating.
I doubt that you can get a loan at a rate that's lower than CD or bond interest, so it seems that in this case you're really comparing fixed interest to equity or real estate gains.
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Old 09-23-2014, 09:54 PM   #14
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I thought I'd mention that I refinanced my home last year and pulled out 100k of the equity (2.875 percent loan). We added a 3 car garage to our home with an existing 2 car garage so my husband could have a workshop. The addition looks good - like it was part of the original construction. We did the inside work ourselves (sheetrock, insulation, electrical, paint, etc.). I spent the remainder of the $$$ to help finance the purchase of 3 additional rental properties.
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Old 09-23-2014, 10:38 PM   #15
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The bond market gives us its best guess at inflation:
implied inflation = nominal bond - TIPS bond

Currently for the 10 year Treasury:
implied inflation = 2.55 - 0.54 = 2.01%
Yes, and probably even less than 2%; with the TIPS part of the 2.01% is a small insurance premium built in for unexpected inflation.
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Old 09-23-2014, 10:48 PM   #16
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I would have done a 30 year mortgage, except my expected projections didn't really make it worthwhile:

In 10 years, I anticipate being married and either living somewhere else (possibly out of town), or tearing down my house and building a dream home. Either way, I don't expect to be in the same house in 15-30 years. Which makes closing costs and other associated expenses for a new mortgage nearly offsetting from the possible benefits.

Also, my alternative at the time (which I now have) is a PenFed 5-year, 1.99% Home Equity Loan. Which enables me to pay down my home much faster at half of the interest expense of what I would be paying on a 30 year loan.
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Old 09-24-2014, 07:58 AM   #17
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That is an awesome deal on the home equity loan. If I could get a fixed rate below 3% it would be a "no-brainer" sign me up now deal.
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Old 09-24-2014, 10:34 AM   #18
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I went with keeping the mortgage and monitoring the earnings of the payoff money.

I paid off my last house, but it was purchased when rates were in the 8% range and never got below 5.25% before I paid it off. Refinancing down over the years was fun.

My current house mortgage is now at 3% fixed. The money from the sale of my last house went into a municipal bond fund that currently has an SEC yield of 3.42% (TTM is 4.24%). If these numbers collide, I will start thinking about it more. But even if the yield were to drop that low, I suspect inflation would keep me in the mortgage down to an even lower yield.
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Old 09-25-2014, 02:35 PM   #19
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That is an awesome deal on the home equity loan. If I could get a fixed rate below 3% it would be a "no-brainer" sign me up now deal.
Well, because of crazy low rates in the 3s on 30-year debt, I would have loved to have had a large liability fixed at that rate for that long as a quasi-hedge against inflation...but since I want to maximize everything based on all available info, I assume that it's likely I will be selling the house in the next 5 years anyway (so the mortgage would be paid off anyway).

Of course, having said all of that, I'll probably wind up living in the same house for the next 30 years even though it's the least likely option.
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Old 09-25-2014, 10:15 PM   #20
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We paid off the house last summer, since I calculated the cash was earning far less than we were paying on interest. We do still carry the Colorado cabin at 3.5% 15 year.
When we move to the PNW next year we may take out a small loan since I doubt the Texas house will net enough to buy something that we will want to stay in for retirement out there, despite downsizing. We'll see. Might sell the cabin, though, although I don't like doing it.
This isn't direct advice to OP; I'm not interested in taking on much of a mortgage and wouldn't consider it at all, were it not for the still low rates.
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