Pay off mortgage or put money into bond fund?

[rayvt]

I've read many of the threads on this but felt one part doesn't really get discussed much. So perhaps I am missing something. Let's say you have 1.25 million in cash but have a mortgage of $250k paying $1350 a month on it. Your SWR is 4% which is $50,000 a year but you spend $16200 for the mortgage so you have $33800 to spend each year other than the mortgage (plus SS, any pension).

But you then pay the mortgage leaving $1 million. At a 4% SWR you then have $40000 to spend each year. Isn't that an argument in favor of paying the mortgage ...at least for those for whom the difference between $33800 and 40000 would be meaningful?

That's an annual difference of $6200.
If you use an SWR of 4.5%, the difference is $4950. But!!! Now the net income (after mortgage payments) is $40,040. That's essentially the same as $40k

If your portfolio is a bit bigger--$1.5M--, the 4%SWR difference is still $6200, but now the net income is $42,800. Bigger than $40K.

So, from one aspect, it all depends on your viewpoint.
Is $40K what you think you need?
Do you want to use a really low SWR? Or are you comfortable with a slightly higher SWR? Why did you pick 4%? Why not 3.9%? Or 3.5%?
Are you focussed on the absolute dollar delta?
If your need is less than $33,800, then there is no need to reach for $40K. It's overkill. How much do you want the rubble to bounce?

De gustibus non disputum.

 

[rayvt]

Also, remember that decisions are made at the margin. "The standard is not perfection. The standard is the alternative."

What other alternatives do you have for the $250K, besides paying off the mortgage?
You could put it in bonds, and earn perhaps roughly the same rate as the mortgage.
You could put it in preferred stocks, and earn more than the mortgage rate.
You could put in in hot internet stocks and either make a fortune or lose it all.
You could leave it in your portfolio, per your chosen asset allocation.

How about this scenario:
Arguably, people who are serious about FIRE and not depending on Social Security for living expenses. (After all, "FI" means you are not depending on the government to give you money, and "RE" means that you are not old enough to collect SS.)
So, when you start collecting SS, it is essentially extra money.
So how about just allocating your SS income to the mortgage payment? In essence, the SS and the mortgage cancel each other out. Eventually, of course, the mortgage will get paid off and then the SS money will become extra spending money.

 

[clifp]

I've read many of the threads on this but felt one part doesn't really get discussed much. So perhaps I am missing something. Let's say you have 1.25 million in cash but have a mortgage of $250k paying $1350 a month on it. Your SWR is 4% which is $50,000 a year but you spend $16200 for the mortgage so you have $33800 to spend each year other than the mortgage (plus SS, any pension).

But you then pay the mortgage leaving $1 million. At a 4% SWR you then have $40000 to spend each year. Isn't that an argument in favor of paying the mortgage ...at least for those for whom the difference between $33800 and 40000 would be meaningful?

I think the missing element in your analysis, is that some of the $16,200 you are paying each year is going toward the paying down the principal. At some point in the future maybe 5,10 or even 30 years in the future the mortgage will be paid off leaving you with $1.25 million portfolio and $50,000 a year while the person who pays of the mortgage still has a $1 million portfolio and $40K/year. Until that time you are correct the person who pays off the mortgage has more spendable income.

 

[Dennis]

all I can say is what has worked for me over the past 10+ yrs now

being in Bonds ave 8.4% apy M* Says my port has done..and a 4.2% ave yld
But, then again, That is going to be taxable come time to take it out

so, maybe paying off the mortgage and when comes time to sell it and that first $500k is Tax Free is the Edge..

It was For me when we sold our home to retire...

The house ave a 7% apy growth, but the sale $ we got was all Tax Free..$350k, even at 15% LT CG's would have left us with only about $298k...
We would have had to earn over 12% apy on our Taxable Bond income to net the same..
The house cost us for the 16 yrs we had it,( 1976-1992) about a total of $112k ( includes RE taxes) & getting $350 = $238 net profit of providing both Housing in a Nice Community and A Piggy bank with some Interest rtn..

 

[rayvt]

The house ave a 7% apy growth, but the sale $ we got was all Tax Free..$350k, even at 15% LT CG's would have left us with only about $298k...

But the house gain is the same whether or not you have a mortgage.

That's how people continually make all sorts of mistakes in housing finance comparisons. There are a lot of subtle issues that are easy to get wrong.

Part of each payment is principal, and therefore isn't a cost--it's just moving your own money around.

The house grows the same with or without a mortgage. You get the entire gain either way.

 

[megacorp-firee]

all I can say is what has worked for me over the past 10+ yrs now

being in Bonds ave 8.4% apy M* Says my port has done..and a 4.2% ave yld
But, then again, That is going to be taxable come time to take it out

.

Dennis, could you share your portfolio? Trying to figure out how to not to be in the same position when the next r*ccession comes along.

Thanks.

 

[jdw_fire]

I don't know about others, but my refi triggerpoint is if the payment savings for a new 30yrFRM is $100/mo or more. No cashout, just refinance the current balance. (Or you could go by interest savings, which triggers at a slightly higher new rate.)

For a 300K balance and 6% current rate, that would be a new rate of 5.375%. (For int sav: 5.5%)
For a 100K balance and 6% current rate, that would be a new rate of 4
.375% (For int sav: 4.750%)
For a 50K balance and 6% current rate, that would be a new rate of 2
.5% (For int sav: 3.5%)

So the lower the remaining balance, the greater the rate difference would have to be.

your thinking appears to be inconsistant. if you really think that keeping a mortgage is the right thing to do financially then why wouldn't maintaining the largest mortgage possible be even better? but instead of trying to do that your plan actually makes refinancing less likely as the balance goes down and you will never pull money out so you are guaranteed to eventually pay off your mortgage, even though you say keeping a mortgage is the right thing to do.

 

[jdw_fire]

Everything I've ever read w/r/t investments says that "this time it's different" are the 4 most dangerous words every uttered.

so something like the last 10 years (dot com bubble bursting, massive rise in home values, trillions of questionable loans made, massive loan defaults, forclosures, huge drop in housing values [while the average american is drowning in debt] AND a second stock market crash) has happened before?

As long as human nature remains as it is, it is never different this time.

after the great depression, human nature in the US changed and marked a generation for life. there are indications that human nature has again changed (savings rate is way up now)

 

[jdw_fire]

That's an annual difference of $6200.
If you use an SWR of 4.5%, the difference is $4950. But!!! Now the net income (after mortgage payments) is $40,040. That's essentially the same as $40k

actually if you use a 4.5% WR then the difference is 1,250,000*4.5% - 1,000,000*4.5% = 250,000*4.5% = 11,250, not 4,950

If your portfolio is a bit bigger--$1.5M--, the 4%SWR difference is still $6200, but now the net income is $42,800. Bigger than $40K.

So, from one aspect, it all depends on your viewpoint. Is $40K what you think you need?
Do you want to use a really low SWR? Or are you comfortable with a slightly higher SWR? Why did you pick 4%? Why not 3.9%? Or 3.5%?
Are you focussed on the absolute dollar delta?
If your need is less than $33,800, then there is no need to reach for $40K. It's overkill. How much do you want the rubble to bounce?

De gustibus non disputum.

not understanding what point your making. sure, if you have a larger portfolio and you use the same WR the amout withdrawn goes up, so what? how does what you wrote address the question you quoted?

 

[rayvt]

your thinking appears to be inconsistant. if you really think that keeping a mortgage is the right thing to do financially then why wouldn't maintaining the largest mortgage possible be even better? but instead of trying to do that your plan actually makes refinancing less likely as the balance goes down and you will never pull money out so you are guaranteed to eventually pay off your mortgage, even though you say keeping a mortgage is the right thing to do.

A cash-out refi costs significantly more than a straight rate-and-terms refi. And in many cases, the amount you can pull out is small. Case in point: we've refinanced our current house 3 times in 4 years.

Anyway, my post was in response to "Does this mean, for those that advocate not paying off the mortgage, you will refinance indefinitely as your mortgages get close to being paid off? Just wondering how far you would take this." and not a full debate on the size of your mortgage. That's another topic.

 

[rayvt]

so something like the last 10 years (dot com bubble bursting, massive rise in home values, trillions of questionable loans made, massive loan defaults, forclosures, huge drop in housing values [while the average american is drowning in debt] AND a second stock market crash) has happened before?

Correct. This has all happened before. Not the exact details, of course, but the essentials.

after the great depression, human nature in the US changed and marked a generation for life. there are indications that human nature has again changed (savings rate is way up now)

Sorry, that's not "human nature"; that's just changes in behavior details.

Human nature is not trivialities like "savings rate".
Human nature is the concept that there are a set of characteristics, including ways of thinking, feeling and acting, that all 'normal' human beings have in common.

Human nature is why people of today can understand and appreciate the writings and plays of Shakespeare, Homer, Plato, Sun Tzu, etc. We completely understand how the people in those plays & stories are thinking and why they are behaving as they are.

The Soviet Union and the Israel kibbutzim assumed the notion that human nature is malleable. They both foundered because, in fact, human nature is fixed.

The basic components of "fear and greed" explain why there have been, and always will be, booms and busts.

 

[Finance Dave]

I've read many of the threads on this but felt one part doesn't really get discussed much. So perhaps I am missing something. Let's say you have 1.25 million in cash but have a mortgage of $250k paying $1350 a month on it. Your SWR is 4% which is $50,000 a year but you spend $16200 for the mortgage so you have $33800 to spend each year other than the mortgage (plus SS, any pension).

But you then pay the mortgage leaving $1 million. At a 4% SWR you then have $40000 to spend each year. Isn't that an argument in favor of paying the mortgage ...at least for those for whom the difference between $33800 and 40000 would be meaningful?

You're forgetting that once the mortgage is paid off in the first scenario, you'll have $50k/year to spend....so I see it like this...

You can have $33,800 for x years and then $50,000 all years after that

or....

You can have $40,000 for every year

The correct choice financially would take a more complex analysis...just wanted to point out where your argument misses a key point.

 

[Katsmeow]

You're forgetting that once the mortgage is paid off in the first scenario, you'll have $50k/year to spend....so I see it like this...

You can have $33,800 for x years and then $50,000 all years after that

or....

You can have $40,000 for every year

I'm not forgetting but didn't find it entirely relevant. That is, let's say someone is 55 and takes out a 30 year mortgage as described. It is indeed true that 30 years later the mortgage is paid off you know have $50,000 a year. But, by then you may be dead or, optimistically, still alive but most likely won't get as much enjoyment or use out of $50,000 a year then as from $40,000 a year instead of $33,800 a year from 55 to 85.

I guess the point to me is that if someone has the cash flow to easily meet all expenses and desired spending and still have a mortgage at a low rate, then I can understand that. However, it does seem that for those with less cash flow there could be more spending power by paying off the mortgage than by keeping it. I could see the difference between $33,800 a year and $40,000 a year being the difference between meeting basic expenses and having a few thousand more a year for discretionary spending.

 

[Finance Dave]

I'm not forgetting but didn't find it entirely relevant. That is, let's say someone is 55 and takes out a 30 year mortgage as described. It is indeed true that 30 years later the mortgage is paid off you know have $50,000 a year. But, by then you may be dead or, optimistically, still alive but most likely won't get as much enjoyment or use out of $50,000 a year then as from $40,000 a year instead of $33,800 a year from 55 to 85.

I guess the point to me is that if someone has the cash flow to easily meet all expenses and desired spending and still have a mortgage at a low rate, then I can understand that. However, it does seem that for those with less cash flow there could be more spending power by paying off the mortgage than by keeping it. I could see the difference between $33,800 a year and $40,000 a year being the difference between meeting basic expenses and having a few thousand more a year for discretionary spending.

Well now you're forgetting the difference between leaving an asset to your heirs versus not.

 

[jdw_fire]

Well now you're forgetting the difference between leaving an asset to your heirs versus not.

how so? seems to me the "asset" gets left to heirs either way.

 

[rayvt]

My heirs have been told to not expect to inherit any assets other than a BMW sports car that's wrapped around a tree.