A new debate on paying off the mortgage (or not).

[cute fuzzy bunny]

Actually the 4% scenario doesnt specify maintaining your cash balance, it just specifies not going to zero during the period of time being tested. In many instances of trial runs a portfolio may become extremely depleted during or towards the end of a 'run'.

The strategy sounds terrific if you get a fixed rate of return, but returns are variable and multi year periods of negative returns are very common. If you took out your mortgage in late 99 or 2000 with this strategy, I'm thinking it hasnt worked out very well for you over the last 8-9 years. I'd have been chugging down antacid pills by late 2002.

You could have taken on a whole lot more risk, or done a whole lot more diversification than most people and maybe pulled a positive return. But thats a whole different ball of wax.

Once you risk adjust and take into consideration the odds of having a failure to produce a positive return for these less than ten year periods, you find there are no free lunches.

 

[Nords]

If you took out your mortgage in late 99 or 2000 with this strategy, I'm thinking it hasnt worked out very well for you over the last 8-9 years.

Didn't we conclude at some point that the bigger portfolio could handle the sustained downturn more easily?

Admittedly the math gets a little hairier if the mortgage money went to Adelphia, Enron, Worldcom, & Global Crossing...

 

[cute fuzzy bunny]

Didn't we conclude at some point that the bigger portfolio could handle the sustained downturn more easily?

Depends on how it was invested and if the investor blinked at any point and changed allocation or pulled their money out. I didnt have to face that decision but based on all the posts about running for the exits over the last few months, it'd have been a real problem for a fair number of people.

Further, resiliency depends more on the spending side than the investment side when things turn south. Someone with no debt isnt required to spend a penny they dont want to, short of anything that gets their home or freedom revoked. Market goes down 80%, that mortgage payment still needs to be made.

Admittedly the math gets a little hairier if the mortgage money went to Adelphia, Enron, Worldcom, & Global Crossing...

Or the S&P 500, or the Nasdaq 100, or the Total Stock Market.

Havent we heard enough about how those havent gone anywhere (or are still underwater as in the case of the nasdaq) over the last ~10 years?

If you were in REITS, certain high bond/low equity balanced funds, emerging markets or one of another handful of "right place at the right time with absolutely no way of foreseeing that they'd perform the way they did" asset classes, then you did well. In most cases, those asset classes are at the upper end of the risk spectrum.

 

[jclarksnakes]

It seems to me that we can drive ourselves nuts running the numbers on this but what it really comes down to is our own personal feelings about debt. Many here think any debt including a mortgage a mistake. To many others a mortgage is okay and all other debt a mistake. Many others here are generally comfortable with consumer debt. When we made our last mortgage payment in 2002 we considered that a mortgage had done good for us overall and contemplated the possibility of moving into a larger and nicer house with a new mortgage or even a new mortgage on this house so that we could invest the money. In the end our strict "any debt is bad debt" mentality won out and we have lived debt free since then. It seems like the right way to me but may not seem so right to someone with a different outlook on debt.
Jeff

 

[CitricAcid]

It seems to me that we can drive ourselves nuts running the numbers on this but what it really comes down to is our own personal feelings about debt. Many here think any debt including a mortgage a mistake. To many others a mortgage is okay and all other debt a mistake. Many others here are generally comfortable with consumer debt. When we made our last mortgage payment in 2002 we considered that a mortgage had done good for us overall and contemplated the possibility of moving into a larger and nicer house with a new mortgage or even a new mortgage on this house so that we could invest the money. In the end our strict "any debt is bad debt" mentality won out and we have lived debt free since then. It seems like the right way to me but may not seem so right to someone with a different outlook on debt.
Jeff

This is definitely a major point and place of reasoning for many on this board and in this country, but am just wondering why that is. I think ziggy put it very well about the mortgage versus the home equity loan, but also find myself in the situation where I would carry a mortgage, but not take out money to put in the market. Also, to the person who mentioned that the tax break isn't that important (that you would take $10,000 and give back $3,000 anyday), it is true that it is perhaps overstated. But if you pay $10,000 on a $160,000 loan (6.25%) and get back $2,500, you only paid $7,500 of interest, which turns out to be 4.6875%. So, the actual interest percentage is lower than the stated amount, if you include tax benefits.

To CFB, while it is true that it only guarantees that it doesn't go to zero, if you make safer assumptions regarding a shorter time period (like I did in my example with 7 years and 7%), it is safe to say that the actual value of the fixed payment is a lot less than $350,000. Moreover, the $350,000 4% rule is designed so that it could grow and shouldn't fail over time periods involved. It could go down, but it could also go up in a similar manner. The idea being that the amount taken out is generally good enough to keep up with inflation and that you have money leftover when these payments are done.

 

[cute fuzzy bunny]

Another fallacy. You have to deduct the standard deduction from the interest deduction calculation, since you'd probably be using that without a mortgage.

That $10,700 for a married couple filing jointly is a big initial hurdle to jump over and it'd be a pretty big mortgage to get significantly over that much interest. Plus in the later half of a mortgage, the interest "benefit" would decline significantly.

Then theres the part about how this works as a retiree living off of portfolio withdrawals. You have to withdraw the money and pay taxes on it to then get the net deduction of the standard deduction minus actual interest paid. So you'd be paying more in taxes to withdraw the money to pay the loan than you'd be "getting back".

Like I said, works great for an accumulating worker or a retiree with a big inflation adjusted pension. Takes a lot of bad math to make it "work" for an early retiree. Which is probably why 80-something percent of ER's dont have a mortgage.

Not sure where you're going with the firecalc thing. The point is that many runs produce an increased result, many produce a decreased result, and some end up in the same place at the end as the start. To get a 7% return you'd have to take some risk. The level of risk determines the potential for gain and loss. The 4% SWR is not a principal maintenance plan, its a "can I get to the finish line without going broke" plan.

The problem with a fixed calculation is that it doesnt measure the sale of depreciated shares during market down periods. Those shares are no longer there to participate in any ensuing recovery.

You dont need calculators, percentages or any in depth thinking to take a good look at how this can work in real life. Average fixed mortgage rates over the last ten years have been running between 5 and 6%. Yeah, I know, some people got a rate better than that. It wasnt available to 99.7% of the rest of the population.

Looking at vanguards 10 year annualized returns, the only funds that cleanly exceeded the mortgage costs are in the aggressive domestic equities, sector, and the more aggressive international categories like emerging markets and the international explorer fund.

So by taking on a substantial risk, you could have made money. No surprise there. You also enjoyed a ton of volatility and had to stick with those funds through the ten year period.

A few of the balanced funds made it into the 6-7% range. If you had chosen those funds you'd have eked out maybe a percent or two after taxes.

Then you look at the yearly returns for all the funds through that ten year period. There were a ton of negative numbers across almost all the funds from 2000-2003, and there'll be some more this year. Did you sit pat for 3-4 years while seeing 5-25% drops and stay with your plan or did you eat the loss for a year or two and then bail, only to miss the 2003-2005 recovery?

Basically if you picked a lower volatility, safer set of investments, you really wouldnt have gotten much out of it. If you went higher on the risk scale you'd have felt like an idiot and kicked yourself from 2000-2003, felt like a genius from 2003-2005, and you feel like an idiot again this year.

I hate plans like that.

 

[CitricAcid]

For the tax deductibility of mortgage interest, what you said is true, but if you itemize other taxes such as property tax (which you will probably have since you are paying mortgage on a house), state tax and sales tax, then it may not deduct the entire mortgage amount, but it will still decrease the effective rate on the mortgage.

I think you are misrepresenting what I am saying. I am not suggesting that you should take out money and invest it in the market, or that it is a guarantee to pay off in the long run or anything similar to that. I am just saying that the suggestion of the $1160 a month payment needing $350,000 to be misleading and false. The $350,000 4% SWR is intended to last over a long period of time and maintain principle (not maintain principle in the sense that you will have $350,000 every year but maintain principle such that you will still have money leftover... which is the idea, if you don't then your plan fails). It also is meant to keep up with inflation payments, maybe depleting the principle over time as inflation outpaces investment returns, or your personal rate of inflation increases, or many other unforeseen circumstances. This is not the case with a fixed payment on a mortgage. All I am saying is that to produce that $1160 a month and be left over with $0 (like what is being suggested with paying off the mortgage) would require a lot less than $350,000. It could be less than $70k, which would make the investment a good choice, or it could be greater than 70k, which would make the investment a poor choice. I am not suggesting one way or the other.

 

[cjking]

I currently have Excel set up so that the value of my home and any mortgage on it are included in my asset allocation. (Yes I did track down some figures for correlations between house prices and equities, bonds, REITs etc.) I currently have no mortgage, but if I change the Excel Solver constraints to allow a 75% mortgage, it tells me to borrow as much as possible and invest it all in commodities.

This illustrates why common sense should always be allowed to override Modern Portfolio Theory.

 

[cjking]

Actually this thread has given me an idea. Maybe I should include my future minimum spending needs in my asset allocation, as a negative holding in cash equivalent to the cost of an inflation-linked annuity?

 

[cute fuzzy bunny]

At 30 years you need 350,000 to maintain a 95%+ failure rate.

At 15 years, $240k @ 95%

At 7 years, $170k @95%

Do note that in all of those cases, 5% of the time you ran out of money before the end of the run. In each instance you nearly ran out of money or at least went below the 70k principal amount a fair number of times. See 7 year chart below with enough principal to assure a success.

So the 350k number is actually a little low for a 30 year mortgage holding period. You'd need 170k invested for a 7 year period to maintain a non zero balance and the monthly cash flow required. But you'd generally end up losing some of that principal in most instances, not maintain or grow it.

 

[FANOFJESUS]

Money magazine regularly recommends pulling equity out of the house and investing it in the market on their 'One Family's Finances' (or whatever the proper title is) column.

Bleh. My suggestion - with $800,000 equity in your $1,100,000 home, sell the freaking home, buy a $300,000 home outright and invest the $500,000!

But that's just me.

On taking out a loan at 5.5% (or whatever) and investing it in a balanced AA - yes, the long-term math favors it... BUT! in the short term, you can't predict how markets will perform. If they underperform the expected return for the next ten years, how does it affect your plans? (Doesn't necessarily tip the decision one way or the other, but it should be considered.) For me, the certainty of lower monthly expenses via paying off the mortgage trumps the expected higher return of borrowing and investing. I'm fiscally conservative that way.

That's my thinking too sell the expensive home buy a cheaper one then but that money in the market. That way if the market tanks you still have a paid for home.

 

[cute fuzzy bunny]

This illustrates why common sense should always be allowed to override Modern Portfolio Theory.

Indeed. A portfolio of half small cap value and half commodities can throw off a 6.something percent safe withdrawal rate, if you have the guts and future returns are similar to the past.

Enjoy the ride, and bring plenty of pepto bismol and dramamine.

It certainly isnt quite as simple as saying "Why, my mortgage is only 6% and I can make 8% annual returns, so I can make 2%!!!"... :

 

[cjking]

It certainly isnt quite as simple as saying "Why, my mortgage is only 6% and I can make 8% annual returns, so I can make 2%!!!"... :

Funnily enough, I have the option to do something like that. I could borrow at 6.1% to invest in a very safe REIT that's paying dividends of 7.8%.

If I didn't take into account the utility of money, I might be tempted. The fact is that the extra income I would earn would make no difference to my life. Since the extra income is of negligible value, it's not worth taking even a small risk of a significant loss to make it.

 

[cute fuzzy bunny]

I'd like the ticker of the very safe reit that pays out 7.8% because I would invest about two million in it.

Thats if it was safe and paid 7.8% that wasnt severely reduced by taxes or other fees/costs.

Heck I might put $3m into anything very safe that produced almost 8%.

 

[cjking]

It won't help you, as it's British. (Technically it's not a REIT either, even though it is an Investment Trust that invests in Commercial Property.)

If you are curious, Google Foreign & Colonial Commercial Property Trust, ticker FCPT.

If you look at figures over the last year, it won't look that safe. However I would say the current yield should make it safe. Mind you I would have said the same thing at the beginning of June, and the sector fell another 20% in the last two weeks of June.

It has relatively little borrowing and the dividend income is covered by rental income from leases that extend several years, on average.

(Actually the dividend yield is currently 8%, for my decision making purposes I like to use a slightly different figure, calculated from the accounts, which is where I got 7.8%.)

The following link shows the share price is down 52% on a year ago. (As I write I realise you might be starting to doubt my grasp of the meaning of the word "safe." Well it's safer at the current price than at its previous one!)

Details for F&C COMMERCIAL (FCPT) / Market data / Selftrade

The following link contains more information. (You can also use it to link to a list of other funds in the sector, which should demonstrate it's the sector as a whole that's fallen out of favour, the share price fall isn't a result of any particular problem with this fund.)

http://www.trustnet.com/it/funds/?fund=67920

 

[cute fuzzy bunny]

I realise you might be starting to doubt my grasp of the meaning of the word "safe."

Quite perceptive of you. Not exactly US treasuries...

Dont feel bad, you're doing better than the guy that thinks a fund of commodities and foreign bonds is secure from loss and as safe as a money market acct.

Sounds like it has plenty of potential for loss and/or volatility but you think its all wrung out. I dont keep up with real estate in britain that much but I did see an article just a short while that said the RE bubble there in both residential and commercial RE was bigger than the US bubble and still potentially had a good ways to drop.

 

[Texas Proud]

It won't help you, as it's British. (Technically it's not a REIT either, even though it is an Investment Trust that invests in Commercial Property.)

If you are curious, Google Foreign & Colonial Commercial Property Trust, ticker FCPT.

If you look at figures over the last year, it won't look that safe. However I would say the current yield should make it safe. Mind you I would have said the same thing at the beginning of June, and the sector fell another 20% in the last two weeks of June.

It has relatively little borrowing and the dividend income is covered by rental income from leases that extend several years, on average.

(Actually the dividend yield is currently 8%, for my decision making purposes I like to use a slightly different figure, calculated from the accounts, which is where I got 7.8%.)

The following link shows the share price is down 52% on a year ago. (As I write I realise you might be starting to doubt my grasp of the meaning of the word "safe." Well it's safer at the current price than at its previous one!)

Details for F&C COMMERCIAL (FCPT) / Market data / Selftrade

The following link contains more information. (You can also use it to link to a list of other funds in the sector, which should demonstrate it's the sector as a whole that's fallen out of favour, the share price fall isn't a result of any particular problem with this fund.)

Trustnet Investment Trusts / Fund factsheet

The problem is RENT is only as good as the underlying company that is paying it.... but once that company (such as Enron etc.) stop paying their over inflated rent... you are now back to market rent... or NO rent.... and that is the problem with commercial real estate.... and safe....

 

[Ultimate Cheapskate]

Golly. My advice: Just pay off your &^%#$# mortgage ASAP and get on with enjoying life and the home you OWN, rather than living your life in a spreadsheet.

It's always interesting to talk with people about this issue (and I do, a lot), as the ones who have never experienced the joy of life without a mortgage hanging over their heads generally seem preoccupied with the math, alternative investments, etc., while those without a mortgage seem to be smiling a lot, particularly lately. You only have so much time to worry about this stuff, so what's that time worth?

Stay Cheap!
-Jeff Yeager

 

[Nords]

If you went higher on the risk scale you'd have felt like an idiot and kicked yourself from 2000-2003, felt like a genius from 2003-2005, and you feel like an idiot again this year.
I hate plans like that.

We're keeping ours until 2034. How do we feel over the next 26 years?

Clearly we'll have to come up with enough deductions until then to overcome the standard deduction...

 

[cute fuzzy bunny]

I imagine you'll have some years where you feel like geniuses and some years where you're feeling alright because you're paying the bills with a COLA'd pension and have good investing discipline?

I cant come up with enough deductions to break even with the standard deduction. Even pushing it a little the best I can cough up is about 8k worth.

 

[Bestwifeever]

Question for those who are in the pay-off-the-mortgage campe--would you take the tax hit from a traditional IRA to pay off a $250K mortgage at one fell swoop?

 

[Frugality_of_Apathy]

Question for those who are in the pay-off-the-mortgage campe--would you take the tax hit from a traditional IRA to pay off a $250K mortgage at one fell swoop?

Actually that's not a bad idea. Not putting it in an IRA, of course, but instead of paying extra on the principle just store up the money in other investments until you have enough to pay off the house. That way you get the maximum income deductions by having mostly interest and before the interest drops below the standard deduction you pay it off in full.

 

[Alan]

Question for those who are in the pay-off-the-mortgage campe--would you take the tax hit from a traditional IRA to pay off a $250K mortgage at one fell swoop?

As we approached RE and started the re-allocation process of building cash/low risk buckets it was obvious (to me at least) that paying off the 6.5% mortgage was a good approach before I really started building the cash up.

We are still under age 59.5 so the tax hit of cashing a traditional IRA to pay a mortgage would not make sense to me and I wouldn't do it.

 

[cute fuzzy bunny]

I agree. I wouldnt take a big tax hit just to make the mortgage go away.

Before I er'd I kicked a little extra principal payment in every month and didnt worry about bond allocations. Shortly after I ER'd I paid off the dang mortgage like Jeff said and stopped worrying about a bunch of things.

7 years later, I'm still not worrying about a bunch of things.

If the little bit I could have arbed from having a mortgage would have made or broken my retirement, I'd have stayed at work another year.

If it didnt really make a difference, why worry about it?

 

[chinaco]

I intend to pay off our mortgage by the time I ER in 3 years.

We also have plans of downsizing... but that depends on how the housing market is in 3 years