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Old 02-16-2008, 11:49 PM   #141
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You never used an ARM with a balloon payment.
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I have in mind for this little experiment a 25 yr old couple purchasing their first house.
One of the issues that gets batted around after the fourth of fifth iteration of this discussion is that the median homeowner tenure is seven years.

As a 25-year-old, I'd hesitate to buy a house... especially if I was in the military.
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Old 02-17-2008, 12:59 AM   #142
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Those who say 10.5% - 6% = profit! I ask this, is your portfolio 100% stocks?
My portfolio is not 100% stocks, but then my mortgage rate is only 4.625%, which after the tax break is more like 3.5%. I think I can clear that hurdle.
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Old 02-17-2008, 09:42 AM   #143
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One of the issues that gets batted around after the fourth of fifth iteration of this discussion is that the median homeowner tenure is seven years.

As a 25-year-old, I'd hesitate to buy a house... especially if I was in the military.

Well, replace 25 yr old with 'suitable horizon before retirement'. The tenure thing is interesting but irrelevant, in my opinion. If someone sells their house to buy another, they're still going to make the choice between carrying a mortgage for 30 or 15 years and deciding if they want to pay extra on principal
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Old 02-17-2008, 10:51 AM   #144
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they're still going to make the choice between carrying a mortgage for 30 or 15 years and deciding if they want to pay extra on principal
They are, but they cant control the rates. If they're lucky, this random distribution of mortgage acquisitions every 5-7 years will end up averaging to the average. If they're unlucky and end up moving when mortgage rates are high, while they'll be able to recoup some of that difference by periodically refinancing, its still a loss against the system. On the other hand, if they're lucky and move when rates are very favorable, they get a nice bonus.

But as I've mentioned 100 times now, looking at this from the "I pay x% and can make y%" is ridiculous. The two major factors have nothing to do with rates of excess return from the leverage.

Its about all the lack of gains from your emergency cash and gain reductions by maintaining more fixed income in your portfolio to reduce volatility because you've got payments to make, and whether you can remain a rock in your 6th or 7th year of a bear market while you're sucking the life out of your portfolio to make non-elective payments.

In short: you're taking on more risk of portfolio survival, more payment risk, and weakening your options for a "save" in exchange for a potential to improve your terminal portfolio size. TERMINAL portfolio size.

As far as the "save", someone that has to ante up 15-20k in regular expenses and another 15-20k in mortgage payments a year is going to have to go get a decent regular job to cover those if they really deplete their portfolio. With just the 15-20k in regular expenses and no debt payments, any old part time job will cough up that much.

We often point out that a major bear market in the early years of retirement can be a killer. The more you have at stake, especially in the form of leverage, the more risk of that major bear market in the early years doing you in.

Funny how dang brave some people get when we're in a bull market. Everyone breaks out their two-factor calculators to try and determine how rich they can get by leveraging themselves to the hilt. Good idea when you're young and working. Bad idea when you're 50, have been out of the workforce for 5 years, and you're living off your portfolio.

I still well remember talking about this around here back in late 2002 and early 2003. Dont remember a lot of people encouraged about yanking money out of their house and stuffing it into the market. In fact, at that time I could have gotten a 3.9% 5/1 mortgage and floated the idea of leveraging that. I dont think anyone stepped up to say it was a good idea. Five years was just too short a horizon.

So after an enormous price reduction on the S&P 500, sub 4% rates available on the cost side, but when everyones nervous...dont do it man!

How ya gonna feel when you've just eaten the "price reduction" on your portfolio, your cost is 5-5.5%, and you're freshly introduced to a lot of nervousness.
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Old 02-17-2008, 12:39 PM   #145
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But CFB, I don't recall ever stating or implying that someone should arb their house into the market, much less someone in their 50's. I was showing the numbers for a first-time buyer in their young earning years.

Further, I'll stand by my statement that statistically moving every 7-8 years is irrelevant. Having a 15 or 30 year mortgage on your current house doesn't change your interest rate on your new house. Additionally, one would be stupid to choose to move if rates were prohibitive (understanding that not everyone has a choice on if they move or not, but the vast majority of people I see are simply trying to trade up houses or neighborhoods).

I would by the argument that, if you're planning to move anyway, then a shorter mortgage would make sense as it may give liquidity and allow one to make a bigger down payment on their next house. However, that would assume that, if a bear market hits, it doesn't affect housing prices at the same time.

Your point about losing jobs and bear markets and terminal portfolio value is pertinent when doing a whole personal finance plan, but, for the young earners in my scenario, it seems like they would be even better served by not paying off the mortgage. A 15 yr is a higher hurdle to clear if one doesn't have a job, and pre-paying on the 30 year doesn't help either since your monthly payment doesn't go down. So, in that case, having a larger pot of money available free of the house would help on all fronts...

I assume you were partially just using my post as a springboard for other points you wanted to make about a topic that's been discussed to death, but I never discussed retirees, 50 year olds, or ARMS. I was just presenting the numbers for one couple early in life. One could use those numbers to extend any argument they chose, but that would be their interpretation, not mine.
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Old 02-17-2008, 12:41 PM   #146
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My portfolio is not 100% stocks, but then my mortgage rate is only 4.625%, which after the tax break is more like 3.5%. I think I can clear that hurdle.
Just curious, are you figuring that tax break discount with the standard deduction in mind? The difference between what DW and I would get from a standard deduction and what we get from our mortgage deduction is not a huge amount. We would get almost 11k from the standard and I think we pay about 12k in interest on the house. So we do save about $300 a year in taxes due to the mortgage, but as a % it's pretty insignificant.

We donate a lot, though, and that makes itemizing more worth our while.

To the point of % spreads between shorter and longer term loans, I got ~40 basis points discount at the time for going with a 20 year vs. 30 year, it's always been my personal experience there is always a discount for a shorter term. I think the argument for a paid off house is made a lot stronger in the context of choosing a shorter term mortgage at favorable interest rates vs. arbitrary early payments.

Can one get the child credits/deductions if one uses the standard deduction? Anyone?
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Old 02-17-2008, 12:47 PM   #147
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Just curious, are you figuring that tax break discount with the standard deduction in mind?
Si, Seņor.

In my case, my property taxes, sales taxes, etc are just about the same as my standard deduction. So, I get the full deduction for mortgage interest.

I do understand that not everybody would get the same break I do, but even without the tax break, it's hard to screw up by keeping a 4.625% mortgage, don't you think?
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Old 02-17-2008, 12:49 PM   #148
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Si, Seņor.

In my case, my property taxes, sales taxes, etc are just about the same as my standard deduction. So, I get the full deduction for mortgage interest.

I do understand that not everybody would get the same break I do, but even without the tax break, it's hard to screw up by keeping a 4.625% mortgage, don't you think?
I would agree considering current rates I'd ask you if you were feeling well if you refinanced! :-) How many years do you have left on that loan, on how much principle?
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Old 02-17-2008, 12:53 PM   #149
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I would agree considering current rates I'd ask you if you were feeling well if you refinanced! :-) How many years do you have left on that loan, on how much principle?
That is my refinance rate. I just took out a 15-year at that rate.

In my case, my house was fully paid off. I saw the rate drop to 4.625% on Jan 23. I looked at the 10-year treasury rate on that date. It hadn't been that low since 1960-something.

So, I ran the numbers and decided to take the mortgage arb gamble. As a retiree. Crazy, huh?
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Old 02-17-2008, 01:26 PM   #150
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That is my refinance rate. I just took out a 15-year at that rate.

In my case, my house was fully paid off. I saw the rate drop to 4.625% on Jan 23. I looked at the 10-year treasury rate on that date. It hadn't been that low since 1960-something.

So, I ran the numbers and decided to take the mortgage arb gamble. As a retiree. Crazy, huh?
Interesting. So what did you invest the money in?
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Old 02-17-2008, 01:31 PM   #151
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Interesting. So what did you invest the money in?
Now *that* is an interesting discussion. There are sooooo many opportunites to safely beat a 3.5% after-tax yield.

I'm still deploying the capital, but I like muni CEFs (currently 5% tax-free), high-yield dividend payers (a bunch available at over 4%). I'm even considering wacky stuff like the CPI-indexed exchange traded bonds and real estate with cap rates over 7%.

It's like there's suddenly a cornucopia of interesting investments just as mortgages hit an all-time low.
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Old 02-17-2008, 03:34 PM   #152
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With what money do you pay the mortgage? My emigrant direct is only paying 3.6% and falling and it's taxed. Do you do the bucket thing, dividends enough for the payment? Are all the things you are considering tax free?

My questions are two pronged, one is honest interest and curiousity, and at a larger level, understanding the level of sophistication needed to minimize the increase in risk/volatility and maximize spread. The investment opportunities you mention come and go, is the plan to pay off the mortgage if the investment horizon starts looking bleak?
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Old 02-17-2008, 04:11 PM   #153
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The munis are tax-free, so today we're in a fairly remarkable situation in which one could pay their mortgage interest using the income from a super-conservative tax-free investment, and you'd still pocket the tax break from the mortgage deduction and have a little left over from your muni investment by the end of your mortgage.

That's the conservative case. Since cash flow isn't an issue for me (my investments already throw off more than I can consume), that means I can afford to take a bit more risk.

If you wanted to, it's a fun exercise to modify an amortization spreadsheet and model the monthly outflow vs inflow, annual taxes, etc using a variety of investment assumptions. Use the munis as the most conservative case (in which you'd have to continuously reduce the principal invested), and compare to CPI-linked investments, dividend yielding investments with low growth and low volatility, and higher return higher volatility investments.

We can all make different choices depending on our unique situations, but the bottom-line for me is that it's hard to lose even if you choose the most conservative investment approach.

As far as investment opportunities coming and going, I've only talked about those that are available today. You can lock those yields in for the life of your mortgage.
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Old 02-17-2008, 08:07 PM   #154
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Well, we keep talking about the risk associated with a mortgage, but I haven't seen any numbers. So I started doing some FireCalc runs, with the same methodology I used in that "FireCalc Dips in NW..." thread I started. Seems to me the best measure of risk is what your NW balance is after the worst periods in history. We can all relate to that.

I'm finding some 'interesting' results and some data that (I think) has never been discussed before - but I want to triple check these numbers before presenting.

In the mean time, I've seen that CFB brought up the interesting and often overlooked point that there may be a tax hit for the mortgage payer because he needs that extra cash flow to pay the mortgage. Interesting observation, but I think it is not apples-apples. It appears to be ignoring the tax impact on the guy that does not have a mortgage. Consider:

Two people retire and buy retirement houses. Mr Cash has $1M in his portfolio after buying the house, Mr Mortgage takes out a $200K mortgage, so has $1.2M in the portfolio. So, what were the tax impacts of Mr Cash pulling out that $200K to put towards the house? The simplest assumption is it was MM money with no gains, so no tax impact - OK. But to keep it comparable, that means that Mr Mortgage also has $200K with no gains. That will pay the first 15 years of a 30 year mortgage with no added tax burden. And Mr Mortgage might get the interest write off, offsetting (to some degree) any tax paid in those last 15 years.

I'm bleary eyed from the FireCalc runs, I'm not up to figuring the tax savings on the declining interest of a 30 year mortgage vs added tax on the last 15 years, but I'd love to see it if anyone else is more motivated at this point. What is a decent assumption? 5.5% mortgage, with a 25% marginal tax rate?

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Old 02-17-2008, 08:32 PM   #155
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I'm bleary eyed from the FireCalc runs, I'm not up to figuring the tax savings on the declining interest of a 30 year mortgage vs added tax on the last 15 years, but I'd love to see it if anyone else is more motivated at this point. What is a decent assumption? 5.5% mortgage, with a 25% marginal tax rate?
The tax savings on a 15-year fixed 5.5% $400,000 mortgage for somebody in the 25% tax bracket would be $47,075. Take the total interest of $188,300 and multiply by 0.25.
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Old 02-17-2008, 09:11 PM   #156
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The tax savings on a 15-year fixed 5.5% $400,000 mortgage for somebody in the 25% tax bracket would be $47,075. Take the total interest of $188,300 and multiply by 0.25.
Not necessarily. That is only true if all of the mortgage interest is tax deductible. Many people take the standard deduction, and therefore get no tax benefit from their mortgage interest. And even for those who do itemize, they only get a tax benefit equal to the total of their itemized deductions, minus the standard deduction, which is often less than the total mortgage interest.
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Old 02-17-2008, 09:16 PM   #157
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Not necessarily. That is only true if all of the mortgage interest is tax deductible. Many people take the standard deduction, and therefore get no tax benefit from their mortgage interest. And even for those who do itemize, they only get a tax benefit equal to the total of their itemized deductions, minus the standard deduction, which is often less than the total mortgage interest.
Quite true. Everybody needs to run the numbers themselves, but I chose the example of a $400,000 mortgage so I could assume that the house value was at least $500,000, and I figure anybody with a $500,000 house has enough deductions to make itemizing worthwhile.
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Old 02-17-2008, 09:48 PM   #158
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The tax savings on a 15-year fixed 5.5% $400,000 mortgage for somebody in the 25% tax bracket would be $47,075. Take the total interest of $188,300 and multiply by 0.25.
Thanks - that part is straight forward (I AM getting bleary-eyed).

Part II:

Now for that mortgage, the $400,000 that you didn't put into the house (and I'm assuming has no unrealized gains for the apples-apples comparison with Mr Cash) would pay the first 122 payments (398,736.26). The remaining payments may be hit by the 25% marginal rate ( increased draw from 401K or whatever). And the remaining payments are (drum roll....)

$189,563.14 - times the .25 tax rate = $47,390.79

So, assuming the same tax rate on all - it's basically a wash with your $47,075 .... right?

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Old 02-17-2008, 09:53 PM   #159
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Yes, assuming the investment income is taxed at the same rate, the tax savings/cost should be a wash.

What makes this more fun is that there are several classes of investments which are taxed below your ordinary income rate. Muni interest, dividends, and cap gains for example.
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Old 02-17-2008, 10:43 PM   #160
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That's it, I'm moving back home and living rent-free.
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