Pay off mortgage or put money into bond fund?

[megacorp-firee]

Another positive point is if your house appreciates by 10% you get the full amount, mortgage or not. Leverage can be good.

hmmmm ... isn't this the thinking that got us to where we are today?

 

[audreyh1]

Another positive point is if your house appreciates by 10% you get the full amount, mortgage or not. Leverage can be good.

This is kind of like treading water. If your house appreciates, so likely does replacement housing. Sure, you might be able to downsize and gain a little more, but still. Home appreciation doesn't help that much when you are likely to be an owner most of your life.

Audrey

 

[Bikerdude]

This is kind of like treading water. If your house appreciates, so likely does replacement housing. Sure, you might be able to downsize and gain a little more, but still. Home appreciation doesn't help that much when you are likely to be an owner most of your life.

Audrey

Gains and losses differ by geographic location. People have sold their homes in CA and moved to WA at great profit. However, the point I was making is that you can get the same gain with only 20% down.

 

[rayvt]

a 13% expense reduction is hardly "in the noise" to many LBYM types.

Sure----as long as you only look at one aspect of the picture, and ignore the others aspects. And that's where I run into a problem with aggressive "pay off your mortage" proponents.

That 13% expense reduction doesn't happen in a vacuum. It happens because you've removed money from the "producing earnings & gains" part of your portfolio. That 200K is, for example, no longer earning the 4.26% yield of the Vanguard Total Bond Market fund/ETF (BND). You give up $710/month to save $833/mo (plus a mandatory transfer of $867 from liquid assets to illiquid asset in the form of principal payment).

So your actual net savings is really only $123/mo, not $1700. Plus, of course, the benefit of not being required to convert some of your assets from cash to principal. But that's not a cost, it's just shifting around some of your assets.

Emotionally, I can understand somebody wanting to do this. But financially, not so much. A proponent who touts a $1700/mo savings is lying by omission, if they don't also mention the foregone $710 of earnings and the $867 which is just moving your own money from one pocket to another.

Too, somebody with a $1M or $4M portfolio does not have all of it in BND. They've got a well-diversified portfolio which is probably earning/growing at a long-term blended rate of 6%-8%.

This discussion will never end. Some people feel that saving $123/mo is worth giving up the liquidity. Some people feel that paying $123/mo is well worth the liquidity that this buys them.
De gustibus non disputum.

 

[dizzy]

A proponent who touts a $1700/mo savings is lying by omission, if they don't also mention the foregone $710 of earnings and the $867 which is just moving your own money from one pocket to another.

There is no omission. The 200k was subtracted from the portfolio size (denominator in the SWR becomes 3.8M.) The metric of interest is expenses/portfolioSize.

This discussion will never end. Some people feel that saving $123/mo is worth giving up the liquidity. Some people feel that paying $123/mo is well worth the liquidity that this buys them.

What really matters in the distribution phase is portfolio survivability not liquidity. (You can have a very liquid portfolio and still run out of money.) For a given sequence of returns, survivability is strictly a function withdrawal rate (WR) as a function of time. You can't deny that the initial WR is less by paying off the mortgage in the above case. The only question is whether over time, inflation kicks in to mitigate the difference by devaluing the fixed mortgage payments and thereby lowering the WR of the non-payoff case enough for it to win in the long haul.

I analyzed this pretty heavily a while back for my individual case, my conclusions were:
- with average/low inflation assumptions, to pay off was slightly better
- with high inflation assumptions, to pay off was slightly worse
- in either case the effect of paying off was small (a percent or two in terminal portfolio value).

I believe a percent or 2 is probably within the error tolerance of the entire exercise..... so I went with what would make me feel better (and paid it off). So while its true that emotion factored into my final decision, it was only after the detailed analysis proved inconclusive.

YMMV, of course.

 

[LOL!]

I'd be very reluctant to repay a fixed rate mortgage if it would drain all of my liquid reserves. I don't think 5% interest is too much to pay for a solid liquidity cushion. The only reason you should be considering paying down the mortgage is if you have more than enough in cash and bonds to repay the mortgage and still have enough emergency money left over.

As far as your analysis goes, I wouldn't factor taxes and insurance into your consideration because these payments won't change regardless of weather you pay down the mortgage or not. I also don't think you should look at the payment as a % of monthly cash flow if you are in the position to pay off the mortgage. Just view those monthly mortgage payments as coming from your cash balances if it makes you feel better. After all, that's where the money would come from if you decided to repay the mortgage all at once.

If one is receiving SS benefits and also withdrawing from tax-deferred accounts, then the extra cash flow needed to pay the mortgage can cause those SS benefits to be heavily taxed. If the mortgage had been paid off before SS benefits started, it is possible that one could have reduce income taxes by thousands of dollars.

You have to run some "what-if" scenarios in TurboTax to see the effects.

 

[Dennis]

For most of us, The Home is the Biggest Investment we make and I was raised to Get the House Paid off First, before you go Investing into much anything else, having a Roof over your Head and Paid for is a wonderfull feeling.. ( and of course, your don't go using it like a Bank Loan business either to go buy anything with it, evenpaying for College)

In my community, our homes ave a 8% apy growth for Decades an that's doubling every 9-10 yrs an it will return to that again shortly. But, if you don't live in such a Good Location/State/City etc with that kind of Track record? It may not be worth it to pay it off ASAP.. We retired and moved into another State and a 3.8% APY growth history and thus paying it off early wasn't worth it to us, plus being able to get a 3% Rate Mortge at the time vs what we get on our Bond Portfolio...

Those Living in States with the Homestead act, like Florida are in a Different situation an many pay off their Homes to hide their $ ( or go buy a home down there to do the same thing)

Those in the South West- AZ, Nevada, etc was not a good idea to pay it off an many bought a retirement place down there with very little Down and just walked away when they crashed.. Knowing it will take A 5 yrs to a Decade or longer for their Place to recover it's value ( what my Retired Uncle and some of his friends did an moved back to Illinois ) he told me their street down there was a Ghost Town...
he was glad they decied not to buy their Place and pay for it in Full.. They paid about $10k yr to live in it or they consider it was just Rent..

So, I woul guess, IAD on where you live an the prospects of it's future Growth in value..

 

[megacorp-firee]

Today, I wired the payoff amount to my mortgage holder. The thrill is second only to FIREing. It wasn't a large amount in comparison to our FIRE portfolio and we would have payed it off in 4 or 5 years anyways. So the liquidity we gave up was not that great.

DW had been wanting to do this for a while, so she is happy too.

The psychological boost in this era of recession worrys ... etc. is certainly a welcomed feeling.

 

[W2R]

Congratulations! It is indeed wonderful to know that you will always have your home, especially in these uncertain economic times.

 

[ERD50]

It is indeed wonderful to know that you will always have your home, especially in these uncertain economic times.

Under what circumstances would keeping this:

It wasn't a large amount in comparison to our FIRE portfolio and we would have payed it off in 4 or 5 years anyways.

lead to 'losing your home', compared to paying it off now?

Hey, I get it, for some people it "feels good". So do it. But why try to justify it on economic principals that don't hold water?

-ERD50

 

[Dennis]

Ditto.. And isn't it nice feeling (& kinda Cruel) that when you see those Unfortunate and some are dummies, loosing their Homes ,etc or crying the blues they're having trouble getting refinancing, evicted, abandon, etc. that most had no business buying such big places in the first place..and in questionable areas..

and If it's the Old Homestead with More Bedrooms and Needs maintenace all the time? Consider looking around for a Smaller place that is both Much lower Priced and Had Very little Maintenance for your Retirement Home..

We did this about 5 yrs before retiring and we got a place for only $75k, put $25k into it ( $100k total) & spent Wknds there and Retired in it 5 yrs later and put $200k tx free leftover $ into our Savings in the process.. Since 2003' that $200k has grown to over $300k and we're only about 1.5 hrs from our old place and family & old friends.. but making new one's as well up here in SE Wi. so we can still get Chicago Cubs and Bears Games up here too! and go see the Cubs in a nicer stadium in Milwaukee.

Then we also go South to the Ozarks for a Mo. and then Fla for 3 mos in Winter.. and did 4 cruises last yr and plan to do 5 this yr.. they're really cheap now..

Happy campers!

PS. There are other reasons for Owning your own place... one of which is it is a Forced savings plan into a Piggy bank , that keeps some of your $ out of your Greedy little hands to Invest and loose it..like so many have over the yrs..and keeps Extra $ floating around the House that there is Always a Home for it , when raising a family.. And Wifes Want to Own their own Kitchen and Just in case They want to divorce you, they get the Home..is their Insurance policy..LOL

 

[rayvt]

Well, because lots of people try to convince themselves that what they want to do is objectively the right thing to do. Happens all the time, in all walks of life. How many times does a Ford dealer tell you that a Volkswagon would be a better buy for you?

There's a perfectly good reason & valid to pay off your house mortgage: When the house is a small percentage of your net worth,and you have plenty of liquidity other than the house. 'course, some people would look at this situation and ask, "Why even bother to pay off the house? The monthly payments are trivial, so what's the advantage?"

Our family got a lesson the hard way. My uncle owned a $1M house&land just outside Atlanta, free and clear, and their pension + SS was plenty enough income for them. Then one day he had a chest pain and had an emergency quintuple heart bypass surgery. Medicare pays for a (very short) stay in a convalescent facility that is "street-people" quality. So if you want someplace with middle-class quality facilities and service, you have to pay for it yourself. Cash on the barrelhead. A paid-off house doesn't do you much good when you need $50,000 tomorrow.

 

[Dennis]

RE: rayvt:
All good Points my friend
I left out to also have a HELC.. HomeEquityLineof Credit as soon as you can get one
I keep one and my Bank Revises it every yr.. Up or down at the rate of using a guide we set up of 75% of the est. Resale value of the house, while others use per what their RE taxes say ..and it's just another Insurance Policy, costing us $25 a yr then as we built up credit, the bank waived that after 5 yrs..

fortuntately we never had to use it, but it's nice to have it avail. in time of need.just like keeping a Credit card with $20k LOC around as well, just for emergencies, regardless of what the Rate is, while we use other Credit Cards with Lower rates & Flyer Miles for our daily use.. our neighbor uses a Am. Express Card with a $50k LOC.
and you're right .. Private NH cost around us run about $6-$7k/mo and thus every few yrs we review things to make sure we have emergency $ to tap into , incase we need it , to buy one of us time for a few mo's to set up longer term financing if need be..

Happiness is a back up..several of them if possible

 

[Bestwifeever]

Today, I wired the payoff amount to my mortgage holder. The thrill is second only to FIREing. It wasn't a large amount in comparison to our FIRE portfolio and we would have payed it off in 4 or 5 years anyways. So the liquidity we gave up was not that great.

DW had been wanting to do this for a while, so she is happy too.

The psychological boost in this era of recession worrys ... etc. is certainly a welcomed feeling.

What, you made a financial decision that you felt is the best thing for you and your family in your own personal financial circumstances and you didn't consult us about it first so we could tell you how wrong you are? Let me just say one thing to you in response: CONGRATULATIONS!!!! Now you can pay the mortgage to yourself and watch your savings grow. Or blow it all on bacon--your life, your choice.

 

[clifp]

This is a normally a fairly academic discussion for me because I've figured that at below 5% for both my 1st and Pen Fed HEL it just didn't make sense to pay off the mortgage.

However I am starting to seriously consider doing so, although the arguments about maintaining liquidity are pretty compelling. The way I figure the economic future is even more cloudy than normal, and the prospect of severe weather ahead is worse than anytime in my lifetime.

So I think is worth consider some factors beyond historical rates of return and higher SWR rates. The way I figured we have many possible economic outcomes over the next five or so years. Here are four that I am considering

1. A normal economic recovery with a rise in interest so that 10 Yr T-bills are in the 5-8% range. In which case keeping the mortgage makes sense, although the financial benefit is relatively modest.
2. Hyper-inflation 10-yr T-bills exceed 10% as does inflation. In which case my equities should do fairly well and the ~15% of my liquid assets in inflation protected bonds and inflation sensitive (REITs) assets will do even better and borrowing money at 5% looks positively brilliant.
3. The great recession stretches into many years interest rates remain very low, and the market corrects once the prospect for a good economy gets dimmer.
4. The great depression II hits, interest rates drop lower, commercial real estate collapses and housing continue spiraling downward.

Now personally, my portfolio and my ability to remain retired are fine under 1-2. In the 3rd scenario I am going have to make modest cuts in my expenditures. The 4th scenario means I will likely have to look for a job in a downright horrific job market.

Right now Schwab and Penfed offer CDs in the 1-3.2% range for up to 5 years and 5 year ladder yields approximately 2.5% (all considerably higher than money market funds). It seems me that if I replace 280K ~5% mortgage vs a CD ladder I am decreasing my interest expense by $14K a year while decreasing my income by $7K a year. It seems me that I have a net $7K gain. I am missing something?

 

[ERD50]

It seems me that if I replace 280K ~5% mortgage vs a CD ladder I am decreasing my interest expense by $14K a year while decreasing my income by $7K a year. It seems me that I have a net $7K gain. I am missing something?

No, that seems about right (at current interest rates). You can't come out ahead borrowing at 5% and investing at 2.5%, right? I think this was discussed a while back when some "expert" said that it was almost always best to pay down the mortgage, but he included all these conditions that "made" him right.

When I've done those FIRECALC runs, I always maintained the same AA with and w/o the mort. So what that basically says is, your AA and SWR keep you ahead of inflation in all those successful historical scenarios. And in my runs, that same AA and SWR (with correspondingly larger portfolio) also beat a 5% fixed mortgage (slightly).

-ERD50

 

[Bikerdude]

Right now Schwab and Penfed offer CDs in the 1-3.2% range for up to 5 years and 5 year ladder yields approximately 2.5% (all considerably higher than money market funds). It seems me that if I replace 280K ~5% mortgage vs a CD ladder I am decreasing my interest expense by $14K a year while decreasing my income by $7K a year. It seems me that I have a net $7K gain. I am missing something?

Well we can't argue with the math the way you have done it. However you are comparing short term rates with possibly 15yr or 30 yr rates (ERD50 mentions this in his reply). You need to include the tax savings on the interest deduction.

I guess if you feel inflation and interest rates are going to remain low for an extended period of time (say 10yrs) then that would help to improve your case . In your last scenario, a depression, I would think your home would plummet in value but 30 yr treasuries would do very well.

 

[megacorp-firee]

Under what circumstances would keeping this:
lead to 'losing your home', compared to paying it off now?

The amount to pay off was just over 2.5% of our portfolio and about 1% networth, so in my mind, not significant either way. So if that happens (losing the home), we would have been in trouble either way. So we paid off the 4.875% mortgage instead of putting the money in a 2.7% CD

Hey, I get it, for some people it "feels good". So do it. But why try to justify it on economic principals that don't hold water?
-ERD50

Our mode of operations throughout the years is to NOT play it too close to the edge, so we have always left a considerable (economic and comfort level) margin in all of our transactions.

I seemed to have hit a raw nerve ... what's up ERD?

 

[megacorp-firee]

What, you made a financial decision that you felt is the best thing for you and your family in your own personal financial circumstances and you didn't consult us about it first so we could tell you how wrong you are? Let me just say one thing to you in response: CONGRATULATIONS!!!! Now you can pay the mortgage to yourself and watch your savings grow. Or blow it all on bacon--your life, your choice.

Yep, I scoured the board and this post and figured the time for debate was over ... it was time to 'do or do not', as Yoda would say
... and the occasional slab of bacon never hurt anyone

 

[clifp]

I guess if you feel inflation and interest rates are going to remain low for an extended period of time (say 10yrs) then that would help to improve your case . In your last scenario, a depression, I would think your home would plummet in value but 30 yr treasuries would do very well.

That is the rub, normally when I look in my economic crystal ball, I least have some gut feeling what will happen in the next few years. I am often wrong but seldom in doubt . Now days I really have no clue what the next 5 years is going to bring, and while I use to dismiss gloom and doomers as being tinfoil hat wearers no longer.

I am pretty confident that ERD50 Firecalc runs are right keeping a mortgage slightly improves SWR survival rates. I just wonder if this time it really is different...

 

[rayvt]

I just wonder if this time it really is different...

Everything I've ever read w/r/t investments says that "this time it's different" are the 4 most dangerous words every uttered.
As long as human nature remains as it is, it is never different this time.

 

[Finance Dave]

No. Today the yields are low, true. But in 5 years what will they be? 6%? 7%? If so, you won't be able to change your mind and get that money back out of your mortgage.

To me this is the biggest factor. You lose control of the money if you pay off the mortgage. That's not to say which decision you make...but it's certainly a big factor.

If you pay off the mortgage today, then in 2 years need money (for college loans, car, vacation, home remodel, medical bills, etc.) and have to borrow it...you'll regret your decision.

However, if you have other cash you can rely on later...then this will not be a concern for you...so good luck!

 

[megacorp-firee]

Thread Hijack

Interesting reasonings for not paying off mortgages.

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.

 

[Katsmeow]

I am pretty confident that ERD50 Firecalc runs are right keeping a mortgage slightly improves SWR survival rates.

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?

 

[rayvt]

Interesting reasonings for not paying off mortgages.

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.

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.