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Old 12-15-2008, 11:56 AM   #41
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Originally Posted by ziggy29 View Post
Some thoughts, one at a time:

Assuming you already have a HELOC, maybe. Still, how are you going to make the payments without income? And if you don't already have one, forget about getting one with no job. Reverse mortgage? Maybe in some cases as a last resort, assuming you're at least 62 -- and I think most of us either have (or plan to) not NEED a j*b by age 62. And sell the house? Sure, if you have hundreds of thousands in equity and you buy a much cheaper house or rent (and even renting could be difficult without a job, though maybe with a year's prepaid rent you could get around it.)

Sure -- in fact, this is why some people recommend getting a 30-year mortgage and paying it off like a 15 instead of opting for the 15 -- particularly when the difference in rates are (say) 1/4 point or less. When money is tight, make the minimum payments; other times, pay it down like a 15.

Then again, even with *reduced* cash flow needs, you still have some, and if you've depleted too much cash, you may not have long to meet even the reduced cash flow needs.

Yes, if you prepay the mortgage and manage to hold your job for another couple of years so you can rebuilt a strong emergency fund, it works. But how many of us have that guarantee (or are willing to assume it)? My own financial planning is far too conservative to allow me to assume that and sleep at night.

Points well taken---and thanks for taking the time to explain.
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Old 12-15-2008, 12:08 PM   #42
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Originally Posted by Running_Man View Post
You are missing the offset which is the money that is going to pay off the mortgage is no longer available for the individual who mortgages, while the prepayee is able to invest that stream of cash.
And you are missing a big point (common in these discussions). The person who does *not* prepay, *has* that money invested. He does not need a 'stream of cash' that becomes available from not making a monthly payment, he already *has* the investment. Use those 8% return 5% mortgage rate numbers above for simplicity. You have to keep it Apples-to-Apples:


Person A & B: $500K in savings; $200K mortgage balance.

Person A: Decides to pay off the mortgage - well, that money comes from somewhere, so he now only has $300K in savings. He lost the income stream from that $200K paying 8%.

Person B: Does not pay off mortgage, he has the income stream from the full $500K @ 8%. Yes, that is offset by the interest payment he is making @ 5%. Principal payments are going to his NW. 8% > 5%. But that is the risk that one must accept.


Your scenario seems to be a comparison between pre-paying a mortgage, and burning the money used to prepay the mortgage (because you are ignoring it). I agree, prepayment is better than burning it .

-ERD50
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Old 12-15-2008, 12:28 PM   #43
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--but people do have some options--three things that immediately come to mind are drawing on home equity line of credit ,
Please note that this recently, some posters reported that their HELOCs were frozen - that could happen just when you need it the most. You need to read the fine print, but I'm not certain you can count on this - esp when times are bad - that is exactly when you might need it, and creditors are being careful with loans.

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Correct me if I am wrong, but isn't there some truth in the idea that having a paid off house relieves you of the financial stress/pressure of having to make payments if funds are tight?
Well, there seems to be a strong *emotional* tie to this 'feeling', but it really does not hold water financially as far as I can see.

For rough numbers, say you had a $200K mort balance and a $1K/month P&I payment. If you pre-pay, fine, you need $1K less per month in cash flow. But you no longer have those $200K in investments.

Say you hit a 6 month bad streak - w/o the pre-pay, you can draw down $6K of the $200K to pay the mortgage, one month at a time. Even if the market was down 50% at that time, it's not like you cash in the whole $200K. Plus, in the current market, a SPY ETF is paying 3% yield - even if it was 2%, that dividend cash flow would pay 1/3 of the mortgage w/o any draw down whatsoever.

IOW - what is so stressful about making $6K payments over half a year - when you have $200K available in liquid investments? I'd me more stressed out about putting food on the table, if all my money was tied up in my house, which is not very liquid, and also subject to market fluctuations.

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... if one had invested the market instead of prepaying a mortgage and then the market fell like it has done now, and then they lose their job, the liquidity they thought they had may not be there when they need it most. I mean just like you don't want to sell a house in a down market, you probably don't want to sell your equities in a down market either. As always, thanks!
See above, and remember - that house sure is not liquid!

-ERD50
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Old 12-15-2008, 01:03 PM   #44
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The "opportunity cost" argument to not pre-pay only holds water if you're making more on interest than you're paying on the mortgage.

Using your numbers, $200k needs to make 6 pct after taxes to equal the cash flow of $1k monthly. These are simplistic numbers obviously. But today, what's making more than 6 pct and is as safe as that paid off mortgage?

If you're happy risking this allocation in the market for the potential of a greater return, you MAY reap the benefit. On the other hand, given recent market events I wouldn't count on better than mortgage rate interest level returns for a while. The house is not liquid certainly, but neither is the lost 30-50 pct equities stake.
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Old 12-15-2008, 01:38 PM   #45
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The "opportunity cost" argument to not pre-pay only holds water if you're making more on interest than you're paying on the mortgage.

Using your numbers, $200k needs to make 6 pct after taxes to equal the cash flow of $1k monthly. These are simplistic numbers obviously. But today, what's making more than 6 pct and is as safe as that paid off mortgage?

If you're happy risking this allocation in the market for the potential of a greater return, you MAY reap the benefit. On the other hand, given recent market events I wouldn't count on better than mortgage rate interest level returns for a while. The house is not liquid certainly, but neither is the lost 30-50 pct equities stake.
Those are all reasonable observations. But some of the other posters seem to be pretending that the money used to pre-pay the mortgage does not exist when you don't pre-pay, and that is not a valid comparison.

To get a bit technical - the opportunity cost argument exists. You have to consider the investment return of the money that would be invested. Whether it is advantageous after balancing risk/reward is the calculation and personal decision that needs to be made.

No reason for an equity investment not to be liquid. I could sell my SPY in 6 seconds. Yes, I would take a loss on the amount I need to withdraw ($6K in the example above), if it comes to that. That does not make it illiquid, and the majority is a paper loss at this point, which you might also have in your house.

All I'm saying is, you need to keep it apples-to-apples. I think you will find the differences to be minor, and unpredicatable.

-ERD50
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Old 12-15-2008, 02:21 PM   #46
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Originally Posted by ERD50 View Post
Those are all reasonable observations. But some of the other posters seem to be pretending that the money used to pre-pay the mortgage does not exist when you don't pre-pay, and that is not a valid comparison.

To get a bit technical - the opportunity cost argument exists. You have to consider the investment return of the money that would be invested. Whether it is advantageous after balancing risk/reward is the calculation and personal decision that needs to be made.

No reason for an equity investment not to be liquid. I could sell my SPY in 6 seconds. Yes, I would take a loss on the amount I need to withdraw ($6K in the example above), if it comes to that. That does not make it illiquid, and the majority is a paper loss at this point, which you might also have in your house.

All I'm saying is, you need to keep it apples-to-apples. I think you will find the differences to be minor, and unpredicatable.

-ERD50
The money doesn't exist? This is a capital investment question, the hurdle rate is five percent. Now whether one decides to invest on that basis is understandable, you anticipate a 3 percent return advantage. However there are cash flow issues present and the future cash flow payments reduce the ability to invest in stocks in the future.

At the end of the mortgage both will have a home paid off and stock equity. Who did better is not determined by the average over the entire period versus 5 percent but the amount of after tax cash advantage that the prepayee is able to purchase versus the original equity the mortgagee purchased.

The average return over the period may be a reason to choose an investment but the volatility of stocks makes that not the determining factor at all. IF the stock market were to advance like the ninties and fall off at the end to average 8 percent the advantage of the immediate investment could be far greater than 3 percent.
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Old 12-15-2008, 02:22 PM   #47
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Originally Posted by deepc View Post
The "opportunity cost" argument to not pre-pay only holds water if you're making more on interest than you're paying on the mortgage.

Using your numbers, $200k needs to make 6 pct after taxes to equal the cash flow of $1k monthly. These are simplistic numbers obviously. But today, what's making more than 6 pct and is as safe as that paid off mortgage?

If you're happy risking this allocation in the market for the potential of a greater return, you MAY reap the benefit. On the other hand, given recent market events I wouldn't count on better than mortgage rate interest level returns for a while. The house is not liquid certainly, but neither is the lost 30-50 pct equities stake.
No, at this instant equities are not making 6%. But at other times equities are making 30%, 40%, and 50%. The overall average gain for the S&P500 is about 10.5%.

The problem with paying off the mortgage vs. stock investments is that it is pretty much an irrevocable decision. One you pay principal on the mortgage you can't get it back. The bank won't give any of it back to you if you change your mind. You can only extract money by taking out a new loan or selling the house. So when the time comes where stocks are returning 30%+, your money is locked up in the house, "saving" you the 6% interest you'd otherwise be paying.
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Old 12-15-2008, 02:28 PM   #48
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Please note that this recently, some posters reported that their HELOCs were frozen - that could happen just when you need it the most. You need to read the fine print, but I'm not certain you can count on this - esp when times are bad - that is exactly when you might need it, and creditors are being careful with loans.



Well, there seems to be a strong *emotional* tie to this 'feeling', but it really does not hold water financially as far as I can see.

For rough numbers, say you had a $200K mort balance and a $1K/month P&I payment. If you pre-pay, fine, you need $1K less per month in cash flow. But you no longer have those $200K in investments.

Say you hit a 6 month bad streak - w/o the pre-pay, you can draw down $6K of the $200K to pay the mortgage, one month at a time. Even if the market was down 50% at that time, it's not like you cash in the whole $200K. Plus, in the current market, a SPY ETF is paying 3% yield - even if it was 2%, that dividend cash flow would pay 1/3 of the mortgage w/o any draw down whatsoever.

IOW - what is so stressful about making $6K payments over half a year - when you have $200K available in liquid investments? I'd me more stressed out about putting food on the table, if all my money was tied up in my house, which is not very liquid, and also subject to market fluctuations.



See above, and remember - that house sure is not liquid!

-ERD50

Agreed--and again thanks.
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Old 12-15-2008, 03:28 PM   #49
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Some interesting stats, on the S&P500 rolling 12-month returns, ignoring dividends, from Jan 1972 thru Nov 2008. 432 such periods.

Average 12-month gain: 8.3% (Adding in assumed 3% average dividend, you'd get 11.3%)

Note that these are rolling 12-month periods, so there is some overlap. One very good (or bad) month will be included in the next eleven 12-month periods. For example, of the top 10 gains, 4 are in 1983, 1 is in 1987, 3 are in 1997, and 2 are in 1998. Of the top 10 losses, 6 are in 1974, 1 is in 2001 (September 2001---imagine that!), and 3 are in 2008.

The 3 losses in 2008 tell me why so many people are so scared now.
We are more emotional about recent events than events far in the past. The string of large losses that are happening now are right in our faces.

# of 12-month periods with gain: 312
# of 12-month periods with loss: 120
Average gain of all periods with gain: 16.4%
Average loss of all periods with loss: -12.54%

Average of top 10 gains: 43.9%
Average of top 10 losses: -31.8%
Average of top 43 gains (10th percentile): 35.3%%
Average of top 43 losses (10th percentile): -21.9%
Top gain: Jun 1983, 52.9%
Top loss: Sep 1974, -41.4%

Top 5 gains: 52.9%, 51.8%, 49.1%, 45.5%, 45.1%
Top 5 losses: -41.4%, -39.5%, -37.5%, -31.8%, -30.8%
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Old 12-15-2008, 05:41 PM   #50
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# of 12-month periods with gain: 312
# of 12-month periods with loss: 120
Average gain of all periods with gain: 16.4%
Average loss of all periods with loss: -12.54%

Average of top 10 gains: 43.9%
Average of top 10 losses: -31.8%
Average of top 43 gains (10th percentile): 35.3%%
Average of top 43 losses (10th percentile): -21.9%
Top gain: Jun 1983, 52.9%
Top loss: Sep 1974, -41.4%

Top 5 gains: 52.9%, 51.8%, 49.1%, 45.5%, 45.1%
Top 5 losses: -41.4%, -39.5%, -37.5%, -31.8%, -30.8%
Top gain: Jun 1983, 52.9%
Top loss: Sep 1974, -41.4%

Are these the 12 month periods ending on the month and year mentioned?

Ha
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Old 12-15-2008, 09:54 PM   #51
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Sep 74 Loss 41.4%

wow. I hardly noticed. I was starting college, drinking beer and trying to find loose wimmen

I knew that was a brutal Bear market but wow.

Just wow
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Old 12-15-2008, 10:52 PM   #52
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Top gain: Jun 1983, 52.9%
Top loss: Sep 1974, -41.4%

Are these the 12 month periods ending on the month and year mentioned?

Ha
Yes.

More info:
If you use Faber's 10 month SMA in/out strategy, the average gain (ignoring both dividends and interest on cash) was 8.0% vs. 8.3% for B&H.

BUT!!!!
The top loss was -27.0% vs. -41.4%.
The top gain was 49.1% vs. 52.9%
The average of the top 10 gains was 40.1% vs. 43.9%.
The average of the top 10 losses was -17.9% vs. -31.8%.
So you reduce the top gain(s) and the overall average gain only a little, while reducing the top loss(es) by a lot.
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Old 12-15-2008, 11:47 PM   #53
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This is certainly true. But it's also true that draining liquidity can be a dangerous move, especially when the economy stinks.

Over a very long period of time, plowing a pile of cash into the market is likely to "beat" prepaying a mortgage or holding a lot of cash. But not *all* of financial planning is about maximizing returns; some of it is about securing what you have as well.

If one prepays a mortgage with a lump sum of cash today, I only hope they either (a) can honestly and confidently state that they have a VERY secure income stream and (b) they still have a sound emergency fund. The worst thing one can do is take most of their liquid cash, prepay the mortgage, and then lose their job while the roof leaks and the car breaks down.

We're living in a time when liquidity is crucial to financial security for most people. And even if stockpiling cash at 2% stinks, it stinks less than having almost nothing in the bank when a pink slip heads your way.
If the OP's house is about 10% of his NW, and he has a cash emergency fund, plus stocks and bonds outside of investment funds, then that's a different scenario than someone taking 70-80% of his NW and dumping it in a house. The first scenario does not present a liquidity problem. I think it's time for the OP to present some numbers. Otherwise, we'll be talking in generalities forever.

We're also forgetting that a person willing to make some money can always find some work. Heck, you can probably work the closing shift at a McDonald's. I haven't worked there in years, but I recall being able to get at least two meals covered a day. Yeah, granted, your CV is going to look kind of weird with a string of professional jobs followed by a job at McDonald's, but what Zig and Haha are talking about are really dire scenarios involving going hungry, so having a weird-looking CV is probably not a big worry.

The other thing you're forgetting is that there is always some severance pay and unemployment insurance. Depending on the OP's monthly minimal budget, he may last close to a year just on that.

Of course, very few plans, ER or temporary unemployment, is going to survive an unfortunate combination of major disasters, but if you can't even stomach the thought of being out of work for a few months to a year, then what are you doing on an ER board?
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Old 12-16-2008, 05:18 PM   #54
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The market turmoil and declines in money market rates are making me rethink my mortgage.

I have a second mortgage (got an 80/15) at 9.125% (ouch) and the difference compared to money markets yields has encouraged me to pay it down. The conventional mortgage is much better and I'll leave it alone for now.

In my opinion the decision rides on 1) what rate you are paying and 2) where you are in your career. High-rate equals early payoff (or refi) and young person = keep the mortgage and take the risk. If I was retired I'd want the house paid for.
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Old 12-17-2008, 07:02 AM   #55
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Paid it off

I paid my mortgage off last May when my 3 year average return for my portfolio dropped to 12.8 percent. Had a three year ARM at 5.125 percent which was to end in July. Best decision I ever made. Now putting $1500 per month back into the market. I ERed 5 years ago.
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