Refinance to ER?

[tulak]

Nords captured it pretty well. And one thing I really can't understand is why anyone would label this subject as 'controversial'? There are two elements, financial and emotional:

FINANCIAL: From everything I've seen, and from what others have reported, there may be a slight positive bias towards keeping the debt - but it depends on your assumptions. I've never seen it make a big difference.

EMOTIONAL: Some people seem to be able to sleep better at night after moving a chuck of money from a diversified portfolio of investments into a single piece of RE. So they should do that if they want, and they can also sleep easier knowing that if they look back at the financial side of things, it probably won't make much difference either way. One caveat (as mentioned by others) is that you want to make sure you maintain sufficient liquidity - that can indeed become a real-life problem.

You've summarized this nicely.

I've spent hours reading the threads regarding paying off the mortgage. By not paying of the mortgage, cash-flow does improve and there seems to be a slight overall advantage. But as you said, it doesn't seem to ever make a big difference.

I should probably start another thread, instead of hijacking this one, but maybe somebody can quickly point out what I'm missing.

If I have 12k/year mortgage payment, at a 4% WR that means I'd need to have 300k in capital to sustain this payment. The initial balance was 190k, but by the pay-off time (let's say 8 years into the mortgage) it would be ~162k. Why would you choose not to pay it off in this case?

And I think I just realized the answer. The WR could be higher, since I'm only dealing with 22 years before this expense is paid-off. Is that right? Are there any other factors that I'm missing?

 

[nun]

The big difference between "pay off or not" isn't so much in the end result, but the difference in available cash. Whether you ultimately end up better off is dependent on investment returns and that number is a very fuzzy. However, the difference in cash flow will be a known quantity.

Right now I have a job and wages are rolling in so I don't mind having a short duration, high monthly payment mortgage because I can support it and like seeing the principal come down by $2000 a month. If I was to ER those wages would go away and I'd want to reduce expenses, so refinancing would be the thing to do.

 

[ERD50]

If I have 12k/year mortgage payment, at a 4% WR that means I'd need to have 300k in capital to sustain this payment. The initial balance was 190k, but by the pay-off time (let's say 8 years into the mortgage) it would be ~162k. Why would you choose not to pay it off in this case?

And I think I just realized the answer. The WR could be higher, since I'm only dealing with 22 years before this expense is paid-off. Is that right? Are there any other factors that I'm missing?

Correct, one factor is the payment stops at some point. Also, the 4% rule assumes the expense increases over time with the CPI, while a mortgage payment is fixed.

When I've roughly tried to compare COLA to Non-COLA income, I've found it represents ~ 12X instead of 25x (the inverse of 4%). So, very roughly the 12K fixed expense would require ~ $150K in the portfolio to support the payment. Or, you can just look at it as expected returns over 30 years versus the mortgage rate, consider taxes, etc. Again, probably small potatoes in the overall scheme of things.

You could plug this into FIRECALC, but I doubt you'll see anything different from what we've discussed. I think the margin of error on our assumptions is probably greater than any real deltas we might experience.

Heck, I'm so agnostic on the subject that one reason I have a mortgage now is that I'm too lazy to do whatever it takes to close it. Auto payments are easy. That, and it is adjustable, and down to ~ 3.5% right now, so I'm not motivated at this point. If rates rise, we will see.

You've summarized this nicely.

Thank you - I tried to keep it as balanced and complete as I could. Hopefully reasonably succinct, but I'm not so good at that

-ERD50

 

[HFWR]

One thing Cute Fuzzy Bunny used to point out is that without a mortgage payment, you "might" be able to reduce your WR, thus lowering your tax rate. Just another factor...

 

[ERD50]

One thing Cute Fuzzy Bunny used to point out is that without a mortgage payment, you "might" be able to reduce your WR, thus lowering your tax rate. Just another factor...

Yes he did. With the thinking that the higher WR would be taxed at (or near) your marginal tax rate. So it could well be a factor (unless your minimum WR from an IRA and/or pensions already exceeds that?).

But once again, it is ignoring the other side of that equation. Where did the money come from to pay off the mortgage? If that money could be cashed in tax free, then the monthly payments could also be made from that tax free stash. And it is usually preferable to stretch a tax payment over time, than to have to take it in one big hit. Or am I missing something? As I recall, CFB never answered that one.

-ERD50

 

[rayvt]

If I have 12k/year mortgage payment, at a 4% WR that means I'd need to have 300k in capital to sustain this payment. The initial balance was 190k, but by the pay-off time (let's say 8 years into the mortgage) it would be ~162k. Why would you choose not to pay it off in this case?

And I think I just realized the answer. The WR could be higher, since I'm only dealing with 22 years before this expense is paid-off. Is that right? Are there any other factors that I'm missing?

Correct on the WR. Plus the bit about the payment not growing with inflation.

But you did miss one (if not THE) significant factor: The opportunity cost.

However you slice and dice it, and notwithstanding the recent "lost decade" of the market, the long-term average growth of the market is about 10%, plus dividends of maybe 2%.

If you allow for a really crappy 22 year period average of half that, it's 5% + 2%, or 7%.
This opportunity cost is 7%, whereas 30 year FRMs are now 4.5% or less.
Of course, you must have adequate cash-flow to make the mortgage payments--but you could draw down the investment portfolio if necesssary.

Giving up 250 BPs is a pretty high price to pay, IMHO, just for a emotional reason. Problem is, lots of people have a hard time with the concept of opportunity cost. They feel the money going out, but don't feel the absense of money coming in. Somehow the lack of new money inflow feels less real than the concreteness of money outflow.

:shrug: Guess that's why my neighbor had to get a part-time job as handyman at a local church but we are going on a cruise.

 

[rescueme]

A close friend & neighbor (also retired) has a fully paid off house. They paid it off when they sold their previous house in Chicago. So, whoopie, no mortgage payment. Except that he just had to go out and get a part-time handy-man job. Better to have a large bank account and a small note than a zero bank account and no note.

Regardless of having debt (in whatever form) while entering retirement, your "friend" was not financially prepared to enter retirement.

Either have the cash flow to handle all your debts (e.g. note/mortgage/CC/etc), or have the assets to handle your expected retirement expenses (without debt), it dosen't matter, since it's the same thing.

Our choice was to enter retirement debt free, with a substantial retirement portfolio. That was always our option, and goal to live our retirement years in the manner we wished - not driven by income/debt constraints.

Sure, one could enter retirement with note/mortgage/other debt, but then you had better have retirement income and/or retirement assets to cover the possibilities. Otherwise you had better planned to stay in the w*rkforce (assuming you were not forced out, or have a physical imparement that will not allow you to continue work).

You see a cross-section of those folks at Wally-World, as well as the window at the local Micky D's...

Retirement isn't for wimps.

 

[deserat]

Nords key point is his COLA'd pension is a very secure financial instrument and he believes he can arbitrage the long-term knowing that - i.e., take the long-term risk by using the money from the mortgage in the market. He can sleep at night as he knows his pension covers his costs.

Most people are *not* in that type of situation, so their decisions work for them both financially and emotionally. It's all about risk tolerance - I and my husband will be in a similar situation to Nords *however* we believe in having a paid off house - plus, we won't be buying a house in an area which has the types of housing costs that Nords has - the arbitrage amount for us wouldn't be worth the hassle factor. Perhaps had we stayed in CA and 'moved' up in our housing tastes, we would have looked at this type of arrangement.

I say run the hnubmers, see what your comfortable with and then do it what you are comfortable with. Other people have other comfort zones. They are the ones who will live with their decisions, not you (unless it's the ants and grasshoppers scenario, which is whole 'nuther post - which I seem to have posted before).

 

[rescueme]

I say run the hnubmers, see what your comfortable with and then do it what you are comfortable with. Other people have other comfort zones.

Exactly. You have to make your own life, your own plans. To try to debate (and yes, I'll admit that I do that once in awhile ) any action on whatever anybody should do is an exercise in futility.

It depends your personal financial situation along with your "life norms" that you apply to your life - your situation.

Each of us can share what we did in a certain situation. However to say that what we did is what everybody else should do is wrong, IMHO.

 

[tulak]

But you did miss one (if not THE) significant factor: The opportunity cost.

However you slice and dice it, and notwithstanding the recent "lost decade" of the market, the long-term average growth of the market is about 10%, plus dividends of maybe 2%.

If you allow for a really crappy 22 year period average of half that, it's 5% + 2%, or 7%.
This opportunity cost is 7%, whereas 30 year FRMs are now 4.5% or less.
Of course, you must have adequate cash-flow to make the mortgage payments--but you could draw down the investment portfolio if necesssary.

This is a lot higher than my forecasted rate of return. I have a real rate of return at about 4%. It might turn out to be higher, and in that case I'm wrong, but I prefer to use a conservative number. This is why I don't take into consideration the opportunity cost, there's too much uncertainty on future rate of return.

The other points regarding inflation, etc, are helpful. It looks like I need to run some numbers. I've been debating if I should refinance and extend the term (Nords, we could actually get a 40 years at ~4.5%), but my personal preference is to not have any debt when we pull the plug (in about 10 years). Of course, at these rates, in ten years from now I might not be in a hurry to pay off the mortgage (something only ERD50's approach: too lazy to deal with paying it off).

 

[tulak]

Yes he did. With the thinking that the higher WR would be taxed at (or near) your marginal tax rate. So it could well be a factor (unless your minimum WR from an IRA and/or pensions already exceeds that?).

Another factor in 2014 could also be the health care subsidy. It might be beneficial to pay off the mortgage in order to lower expenses and qualify for a higher subsidy.

It'll be interesting to see how that plays into the pay off the mortgage discussions.

 

[ERD50]

Another factor in 2014 could also be the health care subsidy. It might be beneficial to pay off the mortgage in order to lower expenses and qualify for a higher subsidy.

It'll be interesting to see how that plays into the pay off the mortgage discussions.

True. But let's say I pay off the mortgage by selling stocks with no cap gains (which a lot of us have), to avoid a big tax bill in one year. I could also use that money to pay the mortgage for many years, and while my 'expenses' would be higher, my taxable income would not be - and I think that is all that matters.

But you are still counting on that investment to kick off some income, and some/all of that could be taxable. So say average returns of 6% could mean another $6,000 in taxable earnings on a $100,000 mortgage (but you could also be much more tax efficient than that). And that could be something to watch for. So I guess it depends just what the true 'marginal rate' of that that extra earnings would be. Good point.

Now dang it, you're gonna get me off on a rant - taxes and credits and deductions and AMT and refundable tax credits (many of which have different AGI thresholds on them), are all so complex these days, calculating the marginal rate isn't as simple as it would seem, and it sure isn't predictable.

-ERD50

 

[nun]

True. But let's say I pay off the mortgage by selling stocks with no cap gains (which a lot of us have), to avoid a big tax bill in one year. I could also use that money to pay the mortgage for many years, and while my 'expenses' would be higher, my taxable income would not be - and I think that is all that matters.

But you are still counting on that investment to kick off some income, and some/all of that could be taxable. So say average returns of 6% could mean another $6,000 in taxable earnings on a $100,000 mortgage (but you could also be much more tax efficient than that). And that could be something to watch for. So I guess it depends just what the true 'marginal rate' of that that extra earnings would be. Good point.

Now dang it, you're gonna get me off on a rant - taxes and credits and deductions and AMT and refundable tax credits (many of which have different AGI thresholds on them), are all so complex these days, calculating the marginal rate isn't as simple as it would seem, and it sure isn't predictable.

-ERD50

This just underlines my point that "pay off or not" arguments that hinge on future returns and taxes etc are pretty pointless. However, I can get behind an argument that refinancing to a lower payment frees up cash to spend.

 

[tulak]

True. But let's say I pay off the mortgage by selling stocks with no cap gains (which a lot of us have), to avoid a big tax bill in one year. I could also use that money to pay the mortgage for many years, and while my 'expenses' would be higher, my taxable income would not be - and I think that is all that matters.

But you are still counting on that investment to kick off some income, and some/all of that could be taxable. So say average returns of 6% could mean another $6,000 in taxable earnings on a $100,000 mortgage (but you could also be much more tax efficient than that). And that could be something to watch for. So I guess it depends just what the true 'marginal rate' of that that extra earnings would be. Good point.

Now dang it, you're gonna get me off on a rant - taxes and credits and deductions and AMT and refundable tax credits (many of which have different AGI thresholds on them), are all so complex these days, calculating the marginal rate isn't as simple as it would seem, and it sure isn't predictable.

Your analysis leads me to believe that it really depends on the individual situation. And I agree that it is not close to simple. I wish it could be easier, but then we'd miss out on all the fun discussions.

This just underlines my point that "pay off or not" arguments that hinge on future returns and taxes etc are pretty pointless. However, I can get behind an argument that refinancing to a lower payment frees up cash to spend.

The best you can do is look at the current environment and see if it makes sense. If it does, forecast with a conservative set of expectations. If after that, it still makes sense, then it's might be worth it.

But I agree that the biggest benefit is increased cash flow.

 

[ERD50]

This just underlines my point that "pay off or not" arguments that hinge on future returns and taxes etc are pretty pointless. However, I can get behind an argument that refinancing to a lower payment frees up cash to spend.

Agreed. I re-re-read (!) your OP, and maybe I can rephrase it a bit so we can see why this keeps getting into 'pay-it-off-or-not' territory, and address that as a side comment.

So in the OP, you are asking for opinions on refinancing a 15 yr mortgage @ 4.5% and 5.5 years remaining to a new 15 year mortgage @ 4% to reduce the monthly bill from $2500 to $1100. Your other posts indicate that:

1) You want to reduce monthly expenses.

2) You aren't so concerned about the total return side of things (or simply recognize it's hard to evaluate and could go either way). and...

3) Carrying the debt for this longer period isn't a concern for you.

Based on that, I don't think anyone has come up with a reason for you to not re-finance. Rather, they gave reasons that they would not re-finance.

Maybe you could expand on your reply in post #4 (30 year mortgage suggestion from Nords). Do you feel that incremental delta is too small to justify doubling the mortgage term ( $2,500 to $1,100 to $770)? Otherwise, this seems to fit in with wanting to reduce your monthly expenses.

OK, so back to the pay-it-off issue for just a moment. Obviously, paying it off reduces your mortgage expenses to zero. So if reduced expenses are the goal, pay-it-off sure fits the bill. I think there is something implied here, that you didn't explicitly state. You don't want to 'mess' with your current portfolio. The advantage of this re-finance is that it does not affect your portfolio - it just trades one mortgage for another. Maybe your funds aren't liquid, maybe you'd have big capital gains, whatever. But pay-it-off means tapping into that, r-fi does not.

So, Readers Digest version - the re-fi seems a fit for you, and you may want to re-think the 30 year option.

At any rate, thanks - I keep thinking about locking in a 30 year at these rates, so this whole process is helping me think that through.

-ERD50

 

[rayvt]

The thing about a 30 year loan is that it gives you options. Having more alternatives rather than fewer is a Good Thing.

A 15 locks you into higher payments than a 30. I know how to pay off a 30 year note in 15 years. Just pay more. But paying off a 15 in 30 is awkward, since the sheriff comes over and puts all your furniture on the sidewalk.

This alternative comes with a price. The rate on a 30 is higher than the rate on a 15.
A quick peek at nationalmortgagealliance.com shows these (300K, approx. zero lender fee):
[term, rate, monthly payment, 1st mo interest]
30Yr: 4.50% $1520/mo, $1125
15Yr: 3.875% $2200/mo $969
20Yr: 4.25% $1858/mo $1063

The freedom of having a $680/mo (31%) smaller payment costs $156/mo (16%) more.

 

[rescueme]

The thing about a 30 year loan is that it gives you options. Having more alternatives rather than fewer is a Good Thing.

True; we paid off our last 30-year note in 5.5 years ....

 

[nun]

Maybe you could expand on your reply in post #4 (30 year mortgage suggestion from Nords). Do you feel that incremental delta is too small to justify doubling the mortgage term ( $2,500 to $1,100 to $770)? Otherwise, this seems to fit in with wanting to reduce your monthly expenses.

OK, so back to the pay-it-off issue for just a moment. Obviously, paying it off reduces your mortgage expenses to zero. So if reduced expenses are the goal, pay-it-off sure fits the bill. I think there is something implied here, that you didn't explicitly state. You don't want to 'mess' with your current portfolio. The advantage of this re-finance is that it does not affect your portfolio - it just trades one mortgage for another. Maybe your funds aren't liquid, maybe you'd have big capital gains, whatever. But pay-it-off means tapping into that, r-fi does not.

Nicely put. Refinancing is all about cash flow for me. I have enough in after tax investments to pay off the mortgage, but I wouldn't have much left so it would be a bad use of my capital. While Im working I don't mind the $2500/month mortgage payment and the thing that got me thinking about this was the insanely low rates and being almost at the point of ERing. The $17000 reduction in my annual expense that refinancing to a 4%, 15 year loan would give me while preserving my after tax capital is very tempting.

The 30 year option is just a bridge too far for me, not worth the extra $300 a month for twice the term. I don't think mortgage rates will suddenly rise so my plan is to keep working for a year or so and aggressively pay down the mortgage while I have the cash coming in so that when I do ER I'll be able to refi a smaller principal balance and have the freedom of a low payment while knowing I could pay it off whenever I liked.