Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 10:56 AM   #1
Thinks s/he gets paid by the post
Hyperborea's Avatar
 
Join Date: Sep 2002
Location: Silicon Valley
Posts: 1,008
Mortgage Paydown as Bond Allocation?

I know the whole series of discussions on keeping a mortgage and investing versus paying it off. This is a sub-topic of that discussion that I didn't see discussed. Let's set up a scenario:

- person in accumulation phase for FIRE
- asset allocation has a set %age towards bonds
- home with mortgage & HELOC (which floats at P +/- some %)

Wouldn't it make sense to use the bond allocation money to paydown the mortgage? At least the floating HELOC which will cost more than the bonds will return? This of course assumes that some "reasonable" amount is kept available in bond/bond-like things.
__________________

__________________
Hyperborea is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 11:02 AM   #2
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
brewer12345's Avatar
 
Join Date: Mar 2003
Posts: 16,391
Re: Mortgage Paydown as Bond Allocation?

I view my fixed rate mortgage as a large short position on the long end of the bond market.

I think it is rational to put your bond allocation into paying down the loans. The only reason I can think of for not doing so is if you can do a little tax arbitrage by paying tax deductible interest while receiving tax free or deferred interest inside a 401k or Roth.
__________________

__________________
"There are three kinds of men. The one that learns by reading. The few who learn by observation. The rest have to pee on the electric fence for themselves."



- Will Rogers
brewer12345 is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 11:06 AM   #3
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
cute fuzzy bunny's Avatar
 
Join Date: Dec 2003
Location: Losing my whump
Posts: 22,697
Re: Mortgage Paydown as Bond Allocation?

Wow, thats exactly what my bottom line point was in all of our "mortgage smiting".

Why keep 40%-60% of your money in a bond fund making 3-4% when you can pay off the bond you issued to the bank at (likely) a higher rate. Especially if you arent getting a huge writeoff from the mortgage interest.

Then with your withdrawal rate cut by 25-50%, you will pay less in taxes, and you can decide whether to maintain the resulting higher stock ratio (because you can take a lot more volatility with a lower withdrawal rate), shift it back to the original ratio, or make it even more conservative because you dont need as much money coming out of the portfolio.

The counter argument is that by taking the mortgage payoff money and putting it into stocks, that the historical return exceeds the mortgage rate.

Nobody ever attempted to explain why, with this configuration, you wouldnt also take lower yielding assets and pay off the mortgage as well.

Isnt that having your cake and eating it too?
__________________
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.
cute fuzzy bunny is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 11:10 AM   #4
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
Re: Mortgage Paydown as Bond Allocation?

Could somebody explain how paying *down* a fixed-rate mortgage makes any sense? * Paying it off, I understand. * But paying it down doesn't reduce your monthly payments, and doesn't affect your interest rate. * You're effectively shortening your term without getting a better rate (which you would have if you simply started out with a shorter term).

So, why not pay the minimum on your mortgage, invest the amount you would have used to "pay down", and when you've accrued enough, pay it OFF?
__________________
wabmester is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 11:18 AM   #5
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
brewer12345's Avatar
 
Join Date: Mar 2003
Posts: 16,391
Re: Mortgage Paydown as Bond Allocation?

Quote:
Could somebody explain how paying *down* a fixed-rate mortgage makes any sense? * Paying it off, I understand. * But paying it down doesn't reduce your monthly payments, and doesn't affect your interest rate. * You're effectively shortening your term without getting a better rate (which you would have if you simply started out with a shorter term).

So, why not pay the minimum on your mortgage, invest the amount you would have used to "pay down", and when you've accrued enough, pay it OFF?
Hmmm, I hadn't thought about that. Personally, I took a 15 year mortgage in part because I knew that I would want to be done paying it off within that time frame and I liked getting a lower rate for it. partial payoff still works for an ARM, though.
__________________
"There are three kinds of men. The one that learns by reading. The few who learn by observation. The rest have to pee on the electric fence for themselves."



- Will Rogers
brewer12345 is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 11:34 AM   #6
Full time employment: Posting here.
 
Join Date: Jan 2004
Posts: 844
Re: Mortgage Paydown as Bond Allocation?

Quote:
Could somebody explain how paying *down* a fixed-rate mortgage makes any sense? * Paying it off, I understand. * But paying it down doesn't reduce your monthly payments, and doesn't affect your interest rate. * You're effectively shortening your term without getting a better rate (which you would have if you simply started out with a shorter term).

So, why not pay the minimum on your mortgage, invest the amount you would have used to "pay down", and when you've accrued enough, pay it OFF?
I guess the argument would be that there are very few, if any, places right now where you can get a *100% guaranteed* rate of return that exceeds even these low mortgage rates...paying off your mortgage, all at once or bit by bit, is a guaranteed return...sure you could invest the additional principal, but wouldn't it stink to have the money to payoff your mortgage and then lose 30-40-50% of it ins some investment gone wrong?
__________________
farmerEd is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 11:52 AM   #7
Thinks s/he gets paid by the post
Hyperborea's Avatar
 
Join Date: Sep 2002
Location: Silicon Valley
Posts: 1,008
Re: Mortgage Paydown as Bond Allocation?

Quote:
I guess the argument would be that there are very few, if any, places right now where you can get a *100% guaranteed* rate of return that exceeds even these low mortgage rates...paying off your mortgage, all at once or bit by bit, is a guaranteed return...sure you could invest the additional principal, but wouldn't it stink to have the money to payoff your mortgage and then lose 30-40-50% of it ins some investment gone wrong?
It's not even that. It's that there is no bond/bond-like investment that beats paying down the mortgage/line of credit. If I'm going to have any asset allocation to bonds doesn't it make sense to reduce my "negative bond" before I build up my "positive bonds"?

Now if the argument is about whether to have or not to have bond allocation then that is a different discussion. Deciding to put the investment money allocated for equities into paying off the mortgage is equivalent to the how much bond allocation discussion.

My mortgage is an ARM but even in the worst case (it climbs the max amount at each adjustment - it's fixed for a number of years though) it will still be cheaper than a fixed rate mortgage for the duration that I will be in the house. However, we do have a HELOC (line of credit) that was used to allow us to purchase the house using a non-Jumbo loan. The rate is roughly comparable to what a 5 year CD returns. It seems that if I was to have any bond allocation I should use it to get rid of the HELOC.

As I understand it, the ARMs payments won't be reduced until a recalculation point. That means that on a 5/1 ARM you won't get a reduction until the first 5 year mark and then at yearly intervals if you make extra principal payments.
__________________
Hyperborea is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 12:38 PM   #8
 
Posts: n/a
Re: Mortgage Paydown as Bond Allocation?

This is consistent with the logic that I used to pay off my mortage. For me in didn't make sense to hold bonds paying less that what I was paying in interest.
__________________
  Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 12:41 PM   #9
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
Re: Mortgage Paydown as Bond Allocation?

Maybe an example would help. Let's say you have a fixed-rate 5% 30-year mortgage. You decide to pay it down by $100K. Maybe you knocked 10 years off your maturity date, but your return on that $100K is 0% for the next 20 years! That's right; you don't magically get a 5% return on that money, you get zip.

Compare 0% with other yields, and even a money market starts looking good
__________________
wabmester is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 01:01 PM   #10
Thinks s/he gets paid by the post
Hyperborea's Avatar
 
Join Date: Sep 2002
Location: Silicon Valley
Posts: 1,008
Re: Mortgage Paydown as Bond Allocation?

Quote:
Maybe an example would help. * *Let's say you have a fixed-rate 5% 30-year mortgage. * *You decide to pay it down by $100K. * *Maybe you knocked 10 years off your maturity date, but your return on that $100K is 0% for the next 20 years! *That's right; you don't magically get a 5% return on that money, you get zip.
I'm not going to grind it out but the return is not zero. If you make an extra principal payment then as you say the monthly payment will be the same but a smaller amount of it will be for interest and a larger amount towards the principal.

In the case of an ARM or a HELOC the amount that needs to be paid every month will change at the recalculation points. If you want to shorten the payment time you will need to continue to pay the same amount as before but to make extra principal payments.
__________________
Hyperborea is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 01:16 PM   #11
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
Re: Mortgage Paydown as Bond Allocation?

Quote:
I'm not going to grind it out but the return is not zero. *If you make an extra principal payment then as you say the monthly payment will be the same but a smaller amount of it will be for interest and a larger amount towards the principal.
You're saying that the bank recalculates your amortization schedule everytime you make a payment? That's not my understanding, but it would be interesting if that could be confirmed.

Quote:
In the case of an ARM or a HELOC the amount that needs to be paid every month will change at the recalculation points. *If you want to shorten the payment time you will need to continue to pay the same amount as before but to make extra principal payments.
Correct, it *might* make sense with a variable-rate, but these days those rates are so low, that I wouldn't be surprised if you could find a *safe* investment that would do better.

I just played the variable rate game with my CU. They gave me a 1.9% rate for a year, so I took it and invested it safely at 3%/year. Not a huge win, but I'll take all of the free money anybody wants to give me.
__________________
wabmester is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 01:32 PM   #12
Full time employment: Posting here.
 
Join Date: Jan 2004
Posts: 844
Re: Mortgage Paydown as Bond Allocation?

>>You're saying that the bank recalculates your amortization schedule everytime you make a payment?

Absolutely...how else are they going to keep track of your extra principal payments and when the loan is paid off?

The payment stays the same, but evertime you pay extra principal the next months regular payment allocates more money to principal and less to interest...the difference between the old interest allocation and the new interest allocation is your "earnings" on the extra principal you paid.



__________________
farmerEd is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 01:34 PM   #13
Thinks s/he gets paid by the post
Hyperborea's Avatar
 
Join Date: Sep 2002
Location: Silicon Valley
Posts: 1,008
Re: Mortgage Paydown as Bond Allocation?

Quote:
You're saying that the bank recalculates your amortization schedule everytime you make a payment? * That's not my understanding, but it would be interesting if that could be confirmed.
Yes, that's exactly what I'm saying. One good place for mortgage information and calculators is "The Mortgage Professor", Jack Gutentag professor emeritus at Wharton. http://www.mtgprofessor.com/Default.htm

http://www.mtgprofessor.com/A%20-%20...gages_work.htm
Quote:
When borrowers elect to increase the amount of their payment, the increment reduces the balance by the same amount. For example, if the borrower paid $699.56 on May 1, the balance would drop by an additional $100 to $99,700.38, which in turn would reduce the interest due in June to $498.51.
__________________
Hyperborea is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 01:38 PM   #14
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
cute fuzzy bunny's Avatar
 
Join Date: Dec 2003
Location: Losing my whump
Posts: 22,697
Re: Mortgage Paydown as Bond Allocation?

Of course banks adjust the amoritization tables. Otherwise making principle only payments wouldnt have any effect.

Some banks dont let you do it though. Not many.
__________________
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.
cute fuzzy bunny is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 01:44 PM   #15
Thinks s/he gets paid by the post
Hyperborea's Avatar
 
Join Date: Sep 2002
Location: Silicon Valley
Posts: 1,008
Re: Mortgage Paydown as Bond Allocation?

Quote:
Some banks dont let you do it though. *Not many.
IIRC you are allowed by law to make up to 10% principal repayment per year with no penalty. *A lender can stop you making more than that or may charge prepayment penalties but that should have been on the disclosure forms when you got the loan.
__________________
Hyperborea is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 01:52 PM   #16
Thinks s/he gets paid by the post
wabmester's Avatar
 
Join Date: Dec 2003
Posts: 4,459
Re: Mortgage Paydown as Bond Allocation?

OK, that makes sense. So, the effect is essentially the same as making a larger down-payment on the initial loan. If that's the case, your "return" should be the same as your mortgage interest rate, and the argument is reduced to the same as the pay-off debate, which has already been explored
__________________
wabmester is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 05:16 PM   #17
 
Posts: n/a
Re: Mortgage Paydown as Bond Allocation?

This is off topic a bit, but does relate to real estate debt.
Real estate can be bought for no money down, or at least nothing oop (out of pocket). Thus, your rate of return is
infinite. Leverage baby! Hard to beat, even if you have
cash to work with. Why tie it up if you don't have to?
There was a phrase from the 60s which described this:
"The creative non-use of cash."

John Galt
__________________
  Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-22-2004, 10:08 PM   #18
Thinks s/he gets paid by the post
 
Join Date: Feb 2003
Location: Mesa
Posts: 3,588
Re: Mortgage Paydown as Bond Allocation?

Quote:
I know the whole series of discussions on keeping a mortgage and investing versus paying it off. *This is a sub-topic of that discussion that I didn't see discussed. *Let's set up a scenario:

- person in accumulation phase for FIRE
- asset allocation has a set %age towards bonds
- home with mortgage & HELOC (which floats at P +/- some %)

Wouldn't it make sense to use the bond allocation money to paydown the mortgage? *At least the floating HELOC which will cost more than the bonds will return? *This of course assumes that some "reasonable" amount is kept available in bond/bond-like things.
Of course no one really knows in advance whether this kind of tradeoff will be a financial advantage in the long run or not. If you only have a few years left on the loan and the loan is several points higher than current bond rates, it's a pretty good bet that making additional payments will be the most advantageous thing to do.

Of course if your current loan rate is low and has at least a couple of decades left, the early payment will probably not ultimately be the best thing for you financially. Rates change and you may be trading a favorable payment this month for several years of lost payment advantage in the future. Although we can't answer the question of what the future holds, you can simulate the early payment effect using FIRECALC and see whether it would have been likely to pay off financially throughout history.

As wab stated, this is exactly equivalent to the mortgage payoff decision. And as in the mortgage payoff decision, people who feel more comfortable without a mortgage don't need to run the simulation to make the decision that is right for them.
__________________
sgeeeee is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-23-2004, 06:50 AM   #19
Full time employment: Posting here.
 
Join Date: Mar 2005
Location: Punta Gorda, FL
Posts: 664
Re: Mortgage Paydown as Bond Allocation?

This is very timely for me. I have just sold some assets and I am having a hard time trying to decied if I should pay down my mortgage or just hold tight and see what happens to rates.

I plan on retireing next May. My loan is at 4 7/8% and I could pay off around 70% now, and the rest by my retirement date if I so choose. I have 12 yrs left on my mortgage. I look at paying it off as locking in 4 7/8% for this term.

I would look at this as a fixed income portion of my asset allocation. Of coarse the problem is getting the cash back out if the need arrises. I also toy with the idea of just buying something like I-bonds figuring rates are rising and odds are that even if rates stay low the spread would not be that great and look at it as insurance if rates were to go up from here.

My other thought is to just payoff the mortgage and continue to invest the former interest part of the payment.

Oh well, 8 months and counting. I'm 47 so I still want to be able to grow my net worth for awhile for a saftey measure. Thus I still want to be able to save in retirement.
__________________
dm is offline   Reply With Quote
Re: Mortgage Paydown as Bond Allocation?
Old 09-23-2004, 11:03 AM   #20
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
cute fuzzy bunny's Avatar
 
Join Date: Dec 2003
Location: Losing my whump
Posts: 22,697
Re: Mortgage Paydown as Bond Allocation?

dm - do what I did. Get a home equity line of credit. Then you've made your home a liquid asset.

And once again, historic data simulations arent necessary. Hyperborea's original point is a good one. It makes no sense to maintain 300k-500k+ in bonds making 3-4% when you can use that money to pay off a 5-6% mortgage.

The rising rate argument also makes no sense to me. If you think rates and inflation will go up, the last thing you want to do is own bonds right now. Buy them after the rates/inflation surge has driven the NAVs dow with all that extra cash you'll have every month that isnt going into a mortgage payment. If rates and inflation dont go up, then you've made a 100% safe 5-6% on the money you used to make the payoff.
__________________

__________________
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.
cute fuzzy bunny is offline   Reply With Quote
Reply

Tags
mortgage


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
Bond Allocation Tiger FIRE and Money 19 05-09-2007 03:23 PM
Bond Allocation Question haha FIRE and Money 20 02-11-2007 10:12 AM
default allocation vs. LV & Corp Bond kat FIRECalc support 1 06-04-2006 04:27 PM
Intermediate Bond Fund Allocation WilliamG FIRE and Money 33 05-10-2006 09:56 AM
Bond Fund Allocation Spanky FIRE and Money 3 12-18-2004 03:31 PM

 

 
All times are GMT -6. The time now is 03:59 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.