Why pay mortgage early?

[ChemEng]

I know Im new to these boards, but Im genuinely shocked to see so many people rush to pay of mortgages early. What am I missing here?

The going rate for a PenFed 30 year fixed rate is 6.5%. Of that ~25% will be tax deductible leaving an real interest rate of only 4.875%. (Obviously if you are in a lower income tax bracket the real interest rate increases appropriately.) Its some of the cheapest money you can borrow.

But even if you exclude the tax shield benefits and use the 6.5% interest rate, you still make more money by investing it in the stock markets over long terms that have historically averaged ~9-10% depending on how you calculate it. Of course taking this course of action exposes you to the volitility in the markets that prepaying your mortgage doesnt...

The other part is that real estate is really strong investment (usually) because it uses OPM--other people's money. When you prepay it down, you are moving losing that leverage benefit and are exposing more of your net worth to risks that you cant diversify away. The proverbial many eggs in one basket.

So like I asked earlier in the thread, what am I missing here?

 

[travelover]

You might want to do a search on this - it has been discussed at length several times.

 

[SecondCor521]

One possible reason is cash flow. My mortgage payment represents about 1/6th of my monthly cash flow; paying it off would give me the flexibility to take a lower paying job and be available for my kids more when they're teenagers at home.

From a strictly wealth-building perspective, I think you're generally correct. But wealth-building is not the only objective for some people.

That being said, I have about 29 years left on a mortgage that has an after-tax cost of 3.86%, and I am currently not prepaying it at all.

2Cor521

 

[Andre1969]

I think peace-of-mind has a lot to do with it. I'm 37, want to retire when I'm 46, and hope to have my mortgage paid off by then.

However, I guess once you get towards the tail end of a mortgage, where you're paying mostly principal anyway, it might not be worth it to pay it off early. I think on most 30-year loans, you hit the point around 23 years into it, where you start paying more principal than interest.

On one hand, you're not getting much of a tax writeoff anymore by that point. However, if you have the funds to pay it off, you might be best off just letting that money sit whereever it's invested, and continue to compound and grow.

 

[maddythebeagle]

http://www.early-retirement.org/forums/f30/paying-down-mortgage-early-29103.html

here is the most recent...

 

[Texas Proud]

You seem to assume that all of the interest is tax deductible... I don't have enough itemized deductions to take them every year, so I double up on one year...

SO, the after tax rate for me is a lot higher than what you say.. AND I still have to pay taxes on my gains and income..

And just not having to pay on a mortgage is great.

 

[W2R]

It really IS great! On the first of every month, I have a big smile on my face.

Having my mortgage paid off before retirement simplifies my ER computations, too. Guess it all depends on what you want.

 

[justin]

Like others have said, no tax benefits for me (not many itemized deductions and in a low tax bracket anyway). I also have an ARM that may eventually readjust to rates exceeding 4.75% (could be as high as 6.75%-7.75% in 3-5 years).

The mortgage is also small relative to my other assets, and I don't want to have to generate cash flow to pay it during ER (it would be ~20% of my monthly expenses, meaning the nest egg would have to be much larger).

But search old threads and you can see ample reasons on both sides.

I will say that I did a cash-out refinance on my mostly paid off house back in 2004 and invested the proceeds in the market. In hindsight, this was an extremely good investment, since my investment returns have far exceeded the 4% or so I have paid each year in interest. I'm thinking about liquidating those investments if the market goes up another 7-10% in the next few months and paying off the mortgage in full.

 

[Andre1969]

You seem to assume that all of the interest is tax deductible... I don't have enough itemized deductions to take them every year, so I double up on one year...

And just not having to pay on a mortgage is great.

That's another thing I forgot about, itemizing versus taking the standard deduction. The standard deduction for 2007 for single filers is $5350 I think. For 2007, I might pay around $6200 in interest. Plus, property taxes this year were around $2925. And I think I paid about $2000 in state/local income tax. And maybe $1000 to charitable contributions.

So in my case, it's worth it to itemize, and the mortgage does help. But, say if it were a married couple, who would otherwise get a standard deduction of something like $10K I'm guessing, it's not nearly as lucrative as you might think.

 

[CyclingInvestor]

I paid mine off to celebrate reaching FI in 2004, as a personal celebration rather than
a financial decision. It was kind of funny that this impressed my mom much more than
when I told her I was retiring (and how much I had saved up), which was many times
more than the mortgage amount.

 

[Wags]

It really IS great! On the first of every month, I have a big smile on my face.

Having my mortgage paid off before retirement simplifies my ER computations, too. Guess it all depends on what you want.

You are right not having a mortgage is GREAT and it does help one during ER.

It also gives one more options if one chooses to remain in the same area or to move to another location after or upon retirement.

Having the $$$$ to spend on something else makes life a little easier.

 

[ChemEng]

It really IS great! On the first of every month, I have a big smile on my face.

Having my mortgage paid off before retirement simplifies my ER computations, too. Guess it all depends on what you want.

I understand where you are coming from. Your perspective is much different than mine right now. Im 27 now with a long time to go before ER. But from where I am now, I would much rather have a $100k in the bank with a $100k mortgage instead of $0 in bank and no mortgage. Even without considering the interest differentials.

The example borders on hyperbole, because I doubt anyone would ever use all their savings to pay down debt. Most would consider that position more risky than the one with debt and savings.

I guess part of my confusion with that position is I view fixed rate mortgages extremely low risk. And if you have the money to cover it in the bank, the risk valuation drops to 0. You would just simply pay it off.

I can appreciate the cash flow perspective for paying it off, but so far only 1 person has suggested it as a reason.

 

[ChemEng]

Thank goodness our house price index hasnt risen like that here in beautiful Kentucky!

I was able to purchase 3 acres with lots of 30yo trees, 1500sqft brick ranch, lean-to barn, utility shed, and detached 2 car garage for $100k.

But back to the conversation at hand.

I think that one other factor that I overlooked is how long you plan on staying at the residence. If its going to be your retirement home, then I suppose it makes some sense to put more down on it. In that case you are looking to pay off the roof over your head instead of using the house as a wealth building tool.

 

[brewer12345]

This has been endlessly debated on the forum, which is why you aren't getting much response. I've been in the camp of not prepaying a low cost mortgage, but I have always hedged my bets with a 15 year fixed, since it usually has a lower rate than a 30 year fixed and principal amortization is pretty rapid. As I get older and more conservative in my investments, I have begun to get more interested in killing the mortgage. I have a job with a lot of potentially income volatility and job security is not exactly bulletproof. As such, having a smaller monthly nut to cover is very appealing.

Still not ready to surrender the cheap leverage, though. I will probably kill off other debt (car loan, student oans) first.

 

[ERD50]

I have an idea, for at least wanting to pay your mortgage down early.....

then you want to pay down your mortgage simply because you hate the thought of being underwater on a loan, or you want flexibility with being able to sell if you need to. A paid down mortgage helps a lot with that.

I'm not sure it makes any difference. For apples-to-apples you need to assume you have the money to pay off the mortgage (or not take one out in the first place) Example:

$500K house purchased - forced to sell later and net $300K on the sale. The two people each have $1M in liquid funds.

Person A takes out a $400K mortgage, puts $100K down. Sells and nets the $300K. The $300K goes to pay off the mort balance, and he needs to add $100K to it. Net loss, = $100K down payment, and $100K cash applied to the upside-down loan which is $200K loss.

Person B pays cash, all $500K. Sells and nets the $300K. Net loss, = $200K.

What's the difference?

I think people often ignore the idea that if you DON'T pre-pay the mortgage, you have that cash available to you for other purposes, like paying off a loss in home value. If you compare HAVING the money to NOT HAVING the money - well that IS a no-brainer!

-ERD50

 

[ERD50]

On the other hand, I think most home buyers are not in a position to even consider paying cash for their house. So, in that case, accelerated paydown is a means of forced savings that people are more easily able to swallow.

My mistake, I thought this was an financial discussion, not a psychological one.

So honestly, what is the point of your post? That it is better to have some money saved if your house value goes down? That is a no brainer. But, you said it was better to have the money in the house than in an account. I disagree with the math.

If people need some rationalization for 'forced savings', that is a different argument altogether. Hey, let Uncle Sam take a big chunk out of your paycheck so you can get that money back interest free in 18 months. Another example of 'forced savings'.

-ERD50

 

[Webzter]

My mistake, I thought this was an financial discussion, not a psychological one.

So honestly, what is the point of your post? That it is better to have some money saved if your house value goes down? That is a no brainer. But, you said it was better to have the money in the house than in an account. I disagree with the math.

If people need some rationalization for 'forced savings', that is a different argument altogether. Hey, let Uncle Sam take a big chunk out of your paycheck so you can get that money back interest free in 18 months. Another example of 'forced savings'.

-ERD50

Where did I ever say that it was anything other than psychology behind wanting to pay a mortgage down? The original poster asked why people might want to. I replied why I thought someone might want to.

Nevermind. you win. what else do you want?

 

[ERD50]

Where did I ever say that it was anything other than psychology behind wanting to pay a mortgage down? The original poster asked why people might want to. I replied why I thought someone might want to.

Nevermind. you win. what else do you want?

Is there some cross posting or deleting of posts going on? Sorry, but I went back to refer to your original post and it seems to be MIA. Maybe I cross-posted from the other threads that were linked? But it doesn't seem to take me back there?

At any rate - there were two components to your post. Yes, one was the emotional component. But the other part (that I meant to address) said:

then you want to pay down your mortgage simply because /deleting the emotional component/ you want flexibility with being able to sell if you need to. A paid down mortgage helps a lot with that.

So, I'm saying - how does paying down the mortgage help with flexibility in selling? You can take my previous example, and rather than paying cash, say one person pre-paid the mortgage over 5 years, the other put that money into an account appropriate for 5 year time frame.

No financial difference right? Or, more accurately, the financial difference comes down to interest rates, rates of return, tax treatment, etc.

Sorry, this was not a matter of 'winning' for me - but I do like to see the emotional component of these mortgage pay-downs separated from the financial component. If someone decides to pre-pay for emotional reasons, fine. But, IMO they should recognize that that is what they are doing, and not afix a finacial component to it that may not exist.

-ERD50

 

[youbet]

ERD50 pretty much hits the target. If we're comparing leaving $100K in an investment portfolio and continuting on with a $100K mortgage vs withdrawing $100K from an investment portfolio and paying off a $100K mortgage, the differences are subtle and relate to liquidity, leverage and your ability to arbitrage the borrowed money.

Say a couple retires with a $1.5MM investment portfolio, home equity and a $100K mortgage. They decide to pay off the mortgage and now have a $1.4MM investment portfolio, $100K greater home equity and no mortgage. It makes them feel great because writing the mortgage check every month was a pita and they felt indebted to "the man." The overall impact to their asset allocation is minor and can be easily adjusted for. It has little bearing on their overall financial position. They feel great about it.

Younger homeowners have more time to take advantage of leverage and arbitrage and have different needs for liquidity. I hinted to my son to assume a low interest, 15 year fixed mortage below 6% rather than almost completely deplete his investment portfolio by paying cash for his house. He hates the monthly payment but benefits from the peace of mind having some liquidity brings and the favorable recent returns in the equities markets.

In the end, I believe the pros and cons of a mortgage vary from situation to situation and are usually small, if not inconsequential, and more subjective than objective. The pros and cons of either case have well known work-arounds providing at least partial mitigation.

Many posters on this thread are making the mistake of assuming paying off the mortgage means having a greater net worth. I believe OP is asking whether it is better to pay off a mortgage or leave the assets in the non-real investment portfolio with total net worth being identical in either case.

Oh...... what did I do? Somewhere around year 20 of a 30 year fixed mortgage, I paid it off for reasons I can't even remember and I don't believe doing so materially impacted my ability to RE. I felt pretty good about it though, and DW was absolutely estatic.

 

[maddythebeagle]

Say a couple retires with a $1.5MM investment portfolio, home equity and a $100K mortgage. They decide to pay off the mortgage and now have a $1.4MM investment portfolio, $100K greater home equity and no mortgage.

I would add that they may even decide with the 1.4 MM portfolio and paid off house to take a smaller bond allocation in the portfolio and keep less cash for expenses.

But Op, would see all of this discussed in earlier threads, wouldnt he....

In the end, I believe the pros and cons of a mortgage vary from situation to situation and are usually small, if not inconsequential, and more subjective than objective. The pros and cons of either case have well known work-arounds providing at least partial mitigation.

excellent response!

 

[DblDoc]

In the end, I believe the pros and cons of a mortgage vary from situation to situation and are usually small, if not inconsequential, and more subjective than objective. The pros and cons of either case have well known work-arounds providing at least partial mitigation.

quote]

I agree. There is no "right" answer. In our case we decided to pay ours down at a rate that will have it payed off at about the time we plan to FIRE for piece of mind and to eliminate it from our expenses. We max out our tax sheltered accounts and have money to invest in taxable so we have flexibility that others may not.

DD

 

[Bigritchie]

I just paid mine off in prep for ER, very nice not having to worry about that mortgage payment, and gives me alot of extra cash per month to screw around with.

 

[ERD50]

I just paid mine off in prep for ER, very nice not having to worry about that mortgage payment, and gives me alot of extra cash per month to screw around with.

Now that is exactly the type of statement that puzzles me, the 'gives me alot of extra cash per month' part. I don't see it.

If you had taken those pre-payments, and put them in an investment, that investment could be paying off cash. Maybe a little more or a little less, depending on all the variables previously mentioned. It could be in your emergency fund, meaning more of your other investments could be allocated to longer term (hopefully higher return) areas.

But how can it be 'a lot more'? Seems you can only say that if you totally ignore the other side of the equation, which is not a prudent thing to do, IMO.

Just to be clear - it's fine with me if you say you 'feel better' about not having a mortgage, or that it simplifies things for you, or that you did the math and it looked to provide some after-tax benefit, or you just wanted to do it. It's the 'a lot of extra cash' that I really question.

-ERD50

 

[SecondCor521]

ERD50,

I think the "a lot of extra cash" is just the mortgage payment not being there every month. And you're right, that's ignoring the large chunk of capital that a person had to toss at the bank to clear off the mortgage. But many people are cash-flow fixated after years of living paycheck to paycheck. (I'm not saying this is necessarily the case with Bigritchie.)

2Cor521

 

[FinanceDude]

Now that is exactly the type of statement that puzzles me, the 'gives me alot of extra cash per month' part. I don't see it.

If you had taken those pre-payments, and put them in an investment, that investment could be paying off cash. Maybe a little more or a little less, depending on all the variables previously mentioned. It could be in your emergency fund, meaning more of your other investments could be allocated to longer term (hopefully higher return) areas.

But how can it be 'a lot more'? Seems you can only say that if you totally ignore the other side of the equation, which is not a prudent thing to do, IMO.

Just to be clear - it's fine with me if you say you 'feel better' about not having a mortgage, or that it simplifies things for you, or that you did the math and it looked to provide some after-tax benefit, or you just wanted to do it. It's the 'a lot of extra cash' that I really question.

-ERD50

It's more of a "comfort factor" than a true financial one. Many one this board have no mortgage, while many others do.

I understand the "opportunity cost" of your premise, however, let's say someone pays off their mortgage 10 years early, and takes that "mortgage payment" of $1500 a month (example), and accelerates their investments? The numbers can work..........