Pay off mortgage

[martyb]

If I paid off my mortgage, I'd probably buy a new boat. I know me.

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[photoguy]

Regarding the sleep at night factor -- having a mortgage always seemed better to me on this front since it preserves the "walk away" option (as well as the options provided by having a pile of money).

Owning a home has always made me a little nervous due to its undiversified nature. Had one coworker whose house in florida was swallowed up by a sinkhole, other acquaintances have had major foundation issues, etc.

 

[Texas Proud]

Hi Texas proud
I don't think the mortgage professor was saying to pay off the mortgage with bonds or cd's. He was saying that an apples-to-apples comparison of paying off a mortgage at a certain interest rate should be compared to the returns of an investment of equal risk - cd's and bonds being those vehicles.

Now you're right, from a practical standpoint, many of us would be pulling $ to pay off a mortgage from an AA that is most likely stocks/bonds. To me, that's when taxes and the amount of time left on the note comes into play as well as inflation (which means real returns) since a standard mortgage won't change with inflation, but your effective returns from your AA will.


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Why would I want to compare something that would never exist

I do not have a stash of CDs that I could cash out and pay off the mortgage, so right there his method is broken for me...

IF I had an AA that had enough CDs to pay it off.... I would rebalance the portfolio after I had paid it off (that is, unless it was low where I could just pay it off without having to rebalance).... so the rate of return on my whole portfolio is the rate I would need to use....

 

[panhead]

Even though this discussion has been beat to death every which way, I still think about this as well. After reading alot of this type of thing at bogleheads, I treat my mortgage like a "negative bond" which needs to be compensated for in my AA. In other words, I need to hold in bonds (or CDs, etc) the balance of my mortgage to offset the 'negative bond' effect it has. If my portfolio was big enough to supply a 2.5% draw rate that covered all of my expenses, including the mortgage payment, I wouldn't even think about paying it off, and I would invest the mortage balance in long term muni bond fund from vanguard. Right now, my portfolio is not that big, so I prefer to hold the mortgage balance in a "principle safe" investment such as CDs or savings account. Right now, this strategy is costing me a liquidity premium, as my mortgage rate is 3.125% and the most I can get out of 5 year CDs right now is about 2.5%. I'm hoping for an arbitrage situation where I will find a CD rate of equal to or higher than my mortgage, but even at a 3% CD rate, I believe the liquidity premium is worth paying due to the flexibility of being able to get my hands on that cash should I need it. (Penfed, are you reading this ;-))

Just my $.02, and probably what it's worth!

 

[pb4uski]

I think it is best to compare my mortgage interest rate to my overall portfolio rate since I don't attempt to match investment cash flows with mortgage cash flows. IOW, I don't attempt to have any investments whose cash flow characteristics mirror my mortgage cash outflows, but rather, everything goes into one pot that is invested 60/40... it was 60/40 before I did my cash out refi and once my mortgage is paid off it will still be 60/40.

My rationale of using the portfolio rate is by analogy to finance theory for corporate investments where you evaluate investments using your weighted average cost of capital (which is in turn based on a mix of cost of equity and cost of debt) rather than the incremental cost of capital. IIRC using incremental cost of capital can bias the investment decision. YMMV.

 

[Senator]

If I had put the $400K it took me to pay off the mortgage into the market instead, I'd be way ahead right now. If the market implodes tomorrow, the payoff would look like a better deal.

I paid off my mortgage in August 2014. When the recent correction was happening, I was glad I paid it off. Now, I wish I had invested it in the market in October.

Of course, next month, I might be glad I did it again. (actually, I am still glad.)

Either way, cash flow is $1,145 higher and no one has a crystal ball. And 5.5% is a lot more palatable than 3.5%

 

[LastOfTheBoomers]

My rationale to pay off mortgage- std deduction was more than itemized

The year was 2008 - Money Market was making almost 0% - paid off 65k remaining mortgage (5 percent interest rate) using emergency funds - still had a year left in the bank

Started banking the mortgage payment to rebuild the emergency fund

So at the time I figured it was the best way to earn 5 % guaranteed

This is a tough decision and timing is everything

 

[pb4uski]

For me, if i paid off my mortgage I would have to reduce my Roth conversion by an amount about equal to my mortgage interest as my itemized deductions excluding mortgage interest are about the same as the standard deduction so I would rather keep the mortgage, do higher Roth conversions and spend less time in the 25% tax bracket once RMDs start.

 

[martyp]

I paid off my mortgage a couple of years ago.

My mortgage interest was my biggest tax deduction. While I was w*rking and when I got to the last 7 years of my mortgage the mortgage interest started to decline to the point that I started to increase my contributions to my 403b to avoid paying taxes on my additional taxable income. The amount increased each year.

The result was that I was pouring more and more money into my retirement savings account. And I was practicing LBYM. Five years later I found that I was living quite well on a fraction of my income and that my pension payments were more than enough to allow me to ER.

 

[sengsational]

For me, since most of my assets are in tax advantaged accounts, I'm trying to stretch out the number of years I keep my income below certain thresholds (for tax purposes).

Not only am I not going to pay it off, but I'm going to use a HELOC to squeeze another year of showing low income, if I can!

 

[Cobra9777]

In my simple mind, debt is something to be avoided except when you have no choice... like when you're 25, with no savings, and need reliable transportation to get to/from your job. It's not intended to boost your investable assets in retirement. That type of balance sheet leverage, and the unnecessary risk and uncertainty it creates, has no place in my retirement plan. I'm not a "sleep better" type. IMHO, it's just an inappropriate "capital structure" for that stage of life. Even worse if you're counting on the market outperforming your mortgage to enable early retirement.

Now... having said that, if you find yourself going into retirement holding a 20-30 year mortgage at sub-3.5%, it's hard to imagine a financial/market scenario that won't favor holding the mortgage. As someone else posted, under that worst-case scenario, the mortgage would be the least of your concerns. OTOH, if I was sub-15 years with a 4-5% rate or above, I would pay it off immediately. FIRECalc and ******** are great tools for quantifying the success rate of your specific mortgage scenario. Just be cautious using all the bullish historical data to evaluate the next 10-15 years. With interest rates at historic lows, I don't think all that historical goodness is a reliable short-term indicator. Many people are quick to tout the current, historic low interest rate environment as justification to hold a mortgage, without realistically thinking through what that means to the other side of the equation.

Lastly, the tax advantage of holding a mortgage is frequently over-valued. I no longer have a mortgage, but when I did, my itemized deductions typically exceeded the standard deduction by about one-fourth the amount of my deductible mortgage interest. At my expected marginal rate of 15% in retirement, the advantage was negligible and would have phased down to zero in just a few years. This is quite easy to project by using your amortization table and applying an inflation factor to the current standard deduction. I'm sure there are scenarios where a meaningful portion (or all) of the deductible mortgage interest exceeds the standard deduction. But given the size of standard deductions these days, I have to believe that is the exception and not the rule.

 

[Texas Proud]

In my simple mind, debt is something to be avoided except when you have no choice... like when you're 25, with no savings, and need reliable transportation to get to/from your job. It's not intended to boost your investable assets in retirement. That type of balance sheet leverage, and the unnecessary risk and uncertainty it creates, has no place in my retirement plan. I'm not a "sleep better" type. IMHO, it's just an inappropriate "capital structure" for that stage of life. Even worse if you're counting on the market outperforming your mortgage to enable early retirement.

Now... having said that, if you find yourself going into retirement holding a 20-30 year mortgage at sub-3.5%, it's hard to imagine a financial/market scenario that won't favor holding the mortgage. As someone else posted, under that worst-case scenario, the mortgage would be the least of your concerns. OTOH, if I was sub-15 years with a 4-5% rate or above, I would pay it off immediately. FIRECalc and ******** are great tools for quantifying the success rate of your specific mortgage scenario. Just be cautious using all the bullish historical data to evaluate the next 10-15 years. With interest rates at historic lows, I don't think all that historical goodness is a reliable short-term indicator. Many people are quick to tout the current, historic low interest rate environment as justification to hold a mortgage, without realistically thinking through what that means to the other side of the equation.

Lastly, the tax advantage of holding a mortgage is frequently over-valued. I no longer have a mortgage, but when I did, my itemized deductions typically exceeded the standard deduction by about one-fourth the amount of my deductible mortgage interest. At my expected marginal rate of 15% in retirement, the advantage was negligible and would have phased down to zero in just a few years. This is quite easy to project by using your amortization table and applying an inflation factor to the current standard deduction. I'm sure there are scenarios where a meaningful portion (or all) of the deductible mortgage interest exceeds the standard deduction. But given the size of standard deductions these days, I have to believe that is the exception and not the rule.

Just a couple of comments.... if the interest rate was as high as you say, then why not do a refi to a lower rate instead of paying it off You say we do not look at the other side.... not exactly sure what you mean, but IMO I do... I do not think that rates can stay this low forever... in 5 or so years a mortgage in the 3% range will be a thing of the past and then your money will be earning more than what you pay....

As for a tax deduction... I agree... but there are a lot of people in high cost areas and the deduction does mean good money in their pocket.... for me, I have to double up on my property taxes every two years just to get over the standard deduction... (hint, my loan balance is low and with a low interest rate the total interest is very low)....

 

[Teacher Terry]

Many of the younger folks on Mr. Money Mustache claim that financially if you have an interest rate under 5% that you are better off to keep investing instead of paying off your mortgage. We paid ours off before we retired & I have never regretted that decision. Was it the smartest thing to do? No clue.

 

[pb4uski]

I would tend to agree with them in that it is more likely than not that your investments will return more than 5% over the long run, some of that investment return will be tax-advantaged qualified dividends and long-term capital gains and mortgage interest is deductible against ordinary income, and younger folks would also presumably have income coming in to make their mortgage payments.

 

[photoguy]

We had a mortgage rate under 5 percent and yeah we put our savings into the market instead of paying it down. However after a while it becomes tiresome to see the huge balance that barely changes so we started increasing our payments.

The bulk of our extra money still went to investments though.


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[EastWest Gal]

A compromise suggestion, as this worked for me: My $0.02:

We always strived to make an extra principal payment each month, just set it and forget it, as soon as we could afford to do so in ~1995. We did this with a 30 yr mortgage in Silicon Valley and here in PA. We refinanced to a 15 yr mortgage in 2003, took out some extra cash for a pool and turned out basement into a music studio and home theater. Even paid extra when times were lean (I lost my job due to a bully boss in 2004, underemployed for 3 years after that until I found my niche). Early this year, looking at mortgage interest deduction vs no house payment--would have paid off 3/2015 (with early payoff principal and interest and extra principal ~$2100/mo). Early this year we realized we would benefit from taking money just sitting in a treasury account to pay it off. So we did. It makes such a difference in our monthly budget not to have >$2K taken out for the house.

I would balance the negative cash flow vs the mortgage interest tax deduction in making your decision. With more cash on hand I would have paid it off in 2013. Paying down extra principal ~$200/mo over many years made a big difference for us--saved a lot of interest. That is a compromise worth considering too.

If you are a high earner, making extra principal payments each month will cut substantially into your interest rate in a rather painless way.

 

[RetireBy90]

A compromise suggestion, as this worked for me: My $0.02:]
I would balance the negative cash flow vs the mortgage interest tax deduction in making your decision. With more cash on hand I would have paid it off in 2013. Paying down extra principal ~$200/mo over many years made a big difference for us--saved a lot of interest. That is a compromise worth considering too.

Wondering if others have considered this, we have other deductions that total about $8K, then state taxes of over $9K, so any mortgage interest even in later years would qualify for deduction. I expect that we will continue to itemize even after FIRE.

A compromise suggestion, as this worked for me: My $0.02:]
If you are a high earner, making extra principal payments each month will cut substantially into your interest rate in a rather painless way.

My thinking is say I have $200/mo to do something with. What is the best use of that spot of money? It would depend upon your personal situation and your personal concerns. From a purely financial point of view, paying on a 4% loan vs an equity investment that should return 6-8% equity would win. You place a higher value on the peace of mind than I do cause your situation and personal situation is different than mine. I just suggest that those considering the choice consider the options.

BTW when I was paying an earlier mortgage many years ago with slightly high rates, I added extra to every payment also. We had paid down our last home to about $70K before we moved and sold it. Certainly that big pile of $$ we received was enhanced by the extra payments.

 

[big-papa]

That's actually our plan to pay extra principal, for now. Not FIRE'd yet, but anticipating it at some indeterminate point in the future (0-5years from now). Till then, OMY. Refinanced last month, which improved monthly cash flow by about $400, ignoring taxes. That was the last major expense which wasn't already addressed before I started working again.

Anyway, once the remaining principal is low enough or the savings are high enough, we'll most likely pay it off at that time - if we don't end up selling the house and downsizing instead.

 

[bw1990]

If you are a high earner, making extra principal payments each month will cut substantially into your interest rate in a rather painless way.

This is what I've been doing. I refinanced several years ago and just kept making the prior payment amount on the mortgage. I view this as further diversifying my portfolio. Sure, I might make an extra 2% on this money and I may also make 3% by converting all of my bonds into stocks. I choose to do neither since I feel it lowers our overall risk profile.

 

[yakers]

To add a psychological/emotional aspect to the conversation, this is my post from a few years back, it might add some flavor (or maybe nothing) to the discussion:

I am my father's son.

Today I made the final payment on my mortgage, paid it off early, very early. Had a 15 year mortgage and paid it off in 11 years.

I can calculate a number of ways that carrying cheap debt is a reasonable way to proceed. But my Dad survived the Depression, it had a profound effect on him and I guess on me. My Grandfather had a coal distribution business in Chicago from about 1905 and was doing well. The coal company provided the coal on credit and the retail customers of my Grandfather were expected to pay him in 30 days. The depression hit and the customers could not pay him and he could not pay the coal company. He was always a good businessman, worked hard, did not cheat or live high and he got wiped out. Like a lot of other people.
*
My father NEVER borrowed money in his life. He saved up and bought a fixer upper house for cash in 1964. Always had old used cars. Never had much money but was never in debt. It worked for him. I have had a few loans in my life for vehicles and paid them off early. Now the mortgage is gone. I have older cars all paid for. No credit card debt, no car debt, no house debt, none, nada, nine, naght, zero, and it feels good.

Now in college I realized that having a fixed attitude about debt is missing part of the financial picture. A lot of people who borrowed money after WWII and leveraged themselves into suburban houses did well for themselves. Some of my uncles did well that way but most didn't. Anyone who bought gold before 1974 must have done well when the dollar was taken off the gold standard. But all that was too speculative for my Dad. I do think there is more to finance then his simple system (don't borrow money and save 10% of what you make) but only if a person really studies finance and has the disclipine to systematically invest.

He had a good life: worked as a truck driver, was never in debt, fought in WWII, raised his 5 kids who all went to college and when he retired had about a 100% replacement of his modest working income. He died over ten years ago and I still miss him. But when I paid the mortgage off it sort of felt like he was there.

 

[poorcarver]

In 2008 we went the other way. We had about eight years to go on a 15 year mortgage and were offered a really sweetheart deal to refi. So we went for a 30 year at an even lower rate. We make an extra principal payment that puts us back on the schedule we were on. But if tough times come all I have to make is a very small payment (the the taxes) to stay in my house. Tough times have not come and we will will be paid off in a few more years. For my money the insurance policy at the bank's cost seemed worth it.

 

[pb4uski]

...I am my father's son. ....But my Dad survived the Depression, it had a profound effect on him and I guess on me. .....
My father NEVER borrowed money in his life. ....

Similar story here, but not quite as extreme. My dad disliked debt and would pay it off as quickly as possible. However, while he was quite successful financially, later in life he said that one of his regrets was not using leverage as advantageously as he could have. That has caused me to try to use leverage prudently and we have had not debt for many years other than our mortgage which can be paid off anytime we want with a few clicks of the mouse.

 

[jkern]

I paid off the remaining balance of my mortgage in September 04' with 9 years remaining at 4.75%. I made a few attempts to calculate whether I came out ahead or behind by paying it off. It makes a huge difference on what hypothetical investment choices were made and what buying and selling decisions were made during the Great Recession.


Based on my assumptions, I came out slightly ahead paying off my mortgage. One important note, I was laid off just after the bottom of the market in March 09'. Would I have stayed the course or panicked and sold. I will never know, but at the time I was sure glad I paid off the mortgage.

 

[albundyz]

For me, the answer to this question becomes one of my own psychological makeup. I did not consciously sculpt my retirement during my work life, but maybe subconsciously, I did. Maybe subconsciously I was constructing a very simple retirement. After we retired, we sold our house and used the equity to buy a nice, recently built bank owned house. So, in effect, we paid off our mortgage. There are good points to be made on both sides of this issue, but for me, it was a matter of constructing the simplest retirement environment. This also contributes to our stress-free lifestyle. We are very happy with this.

 

[Texas Proud]

I know that some here have mentioned paying extra for higher interest rates... I am sure there are many here who remember the high rates of the 70s... I was 'lucky' and qualified for a low rate of 13.5% when I bought my first house...

I paid extra every month... a few years later did a refi down to 9%.... then later got it down somewhere around 7%.... (not sure exactly, just guessing the rates)....

To me these rates deserve to be paid quickly... and if I had one that high I would.... but there is no way I am going to pay off a 3ish% rate early... I have set the payment up in my checking account to pay automatically... I do not have to do a thing... (well, I guess I need to make sure there is money in the account )...