Pay off the mortgage or set it and forget it, what would you do?

[rayvt]

Doesn't the arbitrage play require you to match your 30 year, 3.6% mortgage (which seems a bit high these days) against similar risk, fixed income assets (like Bonds, CDs, etc) in your "investment portolio"?

No.

You match the 30 year mortgage term with the same 30 year period of investment portfolio returns.

The risk in the mortgage is, as we keep saying, failing to make the monthly payments. Even if your "investment portfolio" is no more than the initial mortgage amount, you've got more than enough time to let the long-term compounding investment returns cover the monthly mortgage payment.

I would say that there is no doubt that a reasonable investment portfolio is going to return much more than a 2.5% mortgage over the next 30 years.

 

[harley]

Doesn't the arbitrage play require you to match your 30 year, 3.6% mortgage (which seems a bit high these days) against similar risk, fixed income assets (like Bonds, CDs, etc) in your "investment portolio"?

Otherwise, this is not really arbitrage but just leveraging debt to invest in equities, in which case it's similar to borrowing, at low interest rates, to invest in equities which aren't riskless like using a margin loan to buy stock. It raises the gadfly retort against leveraging a mortgage: would you take out a mortgage against a fully paid house (or take a HELOC) to buy securities (though some might do that fully aware of the risks they're taking).

Yes, you're right (IMO). My current mortgages are at 3.75% and 2.875%. The first one I used the cash freed up to buy a couple of rentals (mortgage free). They've consistently returned over 5%, and are now up to 8% return. I'm pretty happy with that play.

The newer one (2.875%) I'm putting the money in CD ladders. I'm definitely losing out currently, but I'm confident that over the remaining 28.5 years of the mortgage (I'll die before it's paid off) the CD rates will significantly beat the mortgage rate, even including taxes. It's a bet, but one I'm comfortable with.

What I'm not comfortable with is leaving that money sitting in a illiquid asset like a house. I realize others don't feel the same way, but that's me. So in answer to your last question, absolutely yes.

 

[ChrisC]

No.

You match the 30 year mortgage term with the same 30 year period of investment portfolio returns.

The risk in the mortgage is, as we keep saying, failing to make the monthly payments. Even if your "investment portfolio" is no more than the initial mortgage amount, you've got more than enough time to let the long-term compounding investment returns cover the monthly mortgage payment.

I would say that there is no doubt that a reasonable investment portfolio is going to return much more than a 2.5% mortgage over the next 30 years.

I'll have to disagree with your view that you match the interest rate of a 30 year mortgage term with the 30 year returns from your investment portfolio. If you have cash, bonds or fixed income securities in your portfolio that are well below the interest rate of the mortgage it makes sense to pay off the mortgage and be done with it -- aren't you actually losing money as a result of the negative spread? That would be "negative arbitrage", such as borrowing on a 3.6% mortgage interest rate to invest in 2.00% interest paying, bond/fixed rate investments in your portfolio.

One of the compelling reasons of why I kept a mortgage over the years was because the payments were tax-affected, so my real interest rate was considerable lower than the mortgage rate of interest. But the spread between my real rate of interest on my mortgage (now it's coupon rate) and the interest rate on my CDs, cash or bonds has now tipped in favor of paying off the mortgage because I no longer itemize or tax-affect my mortgage payments. Though I hadn't thought about the TIPS position and deal mentioned above by daylatedollarshort.

I think you underweight the risks with keeping the mortgage and overweight the gains and risk of having an investment porfolio that may have its growth primarily as a result of having a strong position in equities. It's not just payment risk you should be concerned with regarding the mortgage, but perhaps you might be better off from a Sequence of Returns standpoint --if we go into an extended bear market -- with not having to pay mortgage debt since being mortgage-debt-free reduces your need to increase the percentage levels of draw downs from your investment portfolio if it's primarily used for living expenses.

Perhaps, I'm making things more complicated and over-thinking the situation, but I doubt it's as simple as looking at your mortgate interest rate and it's maturity and comparing it to the total returns of an investment portfolio ove the same period-- seems like that's an apple ot oranges comparison, stacked in favor of borrowing/keeping the mortgage.

 

[daylatedollarshort]

But the spread between my real rate of interest on my mortgage (now it's coupon rate) and the interest rate on my CDs, cash or bonds has now tipped in favor of paying off the mortgage because I no longer itemize or tax-affect my mortgage payments. Though I hadn't thought about the TIPS position and deal mentioned above by daylatedollarshort.

You have to have bought TIPS years ago to get those kind of rates. I-bonds are paying more than most mortgage rates these days. I-bonds have limits on how much you can buy each year, though there are some ways to stretch those limits a bit. TIPS are pretty pricey right now but if high inflation continues, with a locked in low, fixed mortgage rate that arbitrage may still work.

One article I read suggested buying stocks with dividends that pay more than 2.6%, which is about what 30 year mortgage rates have dropped to this week.

If your investments return 2% and you have a 2.7% mortgage for $200K, you may lose $1.4K in a given year (.7% X $200K), which doesn't seem like a huge risk to me, but YMMV. With the kind of funds most people need to retire early here, often in the millions of dollars, and how many here invest in a stock market that historically may go 50% or more in a given year, losing money due to mortgage arbitrage seem like a pretty minor retirement factor.

I saved more than $1.4K in a year by changing where I shopped for groceries. Yet I don't see posts that say I sleep well at night and I can finally retire now because I changed where I grocery shop, yet the dollars saved may be the same as one could get from paying off a mortgage and potentially not losing money on the arbitrage.

 

[FLJim]

Paying off the mortgage is not purely a math question. It is also a question of mindset. Making the difference between borrowing at 2.5% and earning 2.8% on a dividend portfolio might not make a difference to some people. They might say that 0.3% is a fee to SWAN.
Asking the question a different way. If your house was now paid-for, free and clear, would you take out a mortgage and invest the proceeds??

 

[ChrisC]

You have to have bought TIPS years ago to get those kind of rates. I-bonds are paying more than most mortgage rates these days. I-bonds have limits on how much you can buy each year, though there are some ways to stretch those limits a bit. TIPS are pretty pricey right now but if high inflation continues, with a locked in low, fixed mortgage rate that arbitrage may still work.

One article I read suggested buying stocks with dividends that pay more than 2.6%, which is about what 30 year mortgage rates have dropped to this week.

If your investments return 2% and you have a 2.7% mortgage for $200K, you may lose $1.4K in a given year (.7% X $200K), which doesn't seem like a huge risk to me, but YMMV. With the kind of funds most people need to retire early here, often in the millions of dollars, and how many here invest in a stock market that historically may go 50% or more in a given year, losing money due to mortgage arbitrage seem like a pretty minor retirement factor.

I saved more than $1.4K in a year by changing where I shopped for groceries. Yet I don't see posts that say I sleep well at night and I can finally retire now because I changed where I grocery shop, yet the dollars saved may be the same as one could get from paying off a mortgage and potentially not losing money on the arbitrage.

Fair points. We can, however, I think agree that whatever camp on the pay-off mortgage crowd divide you're lodged, it's not going to make a material, financial difference for those with the ability to retire early and have surplus funds to retire the mortgage at any time without tripping other issues.

Paying off the mortgage is not purely a math question. It is also a question of mindset. Making the difference between borrowing at 2.5% and earning 2.8% on a dividend portfolio might not make a difference to some people. They might say that 0.3% is a fee to SWAN.
Asking the question a different way. If your house was now paid-for, free and clear, would you take out a mortgage and invest the proceeds??

Harley answered that question in the affirmative above. And I thought there once was a well-known poster here who several years ago said he was going to borrow/take out a mortgage and invest in Berkshire Hathaway Class A stock with the proceeds. Nonetheless, in both cases I believe they acknowledge the risk involved in such an undertaking.

 

[daylatedollarshort]

Paying off the mortgage is not purely a math question. It is also a question of mindset. Making the difference between borrowing at 2.5% and earning 2.8% on a dividend portfolio might not make a difference to some people. They might say that 0.3% is a fee to SWAN.
Asking the question a different way. If your house was now paid-for, free and clear, would you take out a mortgage and invest the proceeds??

For me and some other posters here, yes it is purely a math question.

Yes, many posters here with paid off homes do get mortgages or refinance with cash out when rates look good. With mortgage rates currently under 3% and inflation at 5%, a low interest rate, fixed mortgage may be a good, future inflation hedge. If not, the mortgage can always be paid off or refinanced with a no point, no fee mortgage, if rates drop even lower. In my case we have some non-COLA pensions and having a mortgage reduces the impact of potential inflation on our retirement finances. The pensions won't go up over time but neither will the mortgage. Actually the mortgage expense has been reduced because we refinanced twice so far at no cost to us mortgages, so our disposable income has gone up. And I'm not losing money on the arbitrage because I bought a lot of TIPS when rates were higher.

 

[ERD50]

...
Asking the question a different way. If your house was now paid-for, free and clear, would you take out a mortgage and invest the proceeds??

Yes. Absolutely. Have done it (if you consider refinancing with funds available for a pay-off instead). Will do it again in the very near future (purchased home with a Line of Credit from broker, will lock in a mortgage soon. Could have paid cash.) It has paid off well for me.

Any other questions?

Making the difference between borrowing at 2.5% and earning 2.8% on a dividend portfolio...

Dividends are not the only value in a portfolio. Money is fungible, it's all money, growth and divs.

-ERD50

 

[ChrisC]

For me and some other posters here, yes it is purely a math question.

Yes, many posters here with paid off homes do get mortgages or refinance with cash out when rates look good. With mortgage rates currently under 3% and inflation at 5%, a low interest rate, fixed mortgage may be a good, future inflation hedge. If not, the mortgage can always be paid off or refinanced with a no point, no fee mortgage, if rates drop even lower. In my case we have some non-COLA pensions and having a mortgage reduces the impact of potential inflation on our retirement finances. The pensions won't go up over time but neither will the mortgage. Actually the mortgage expense has been reduced because we refinanced twice so far at no cost to us mortgages, so our disposable income has gone up. And I'm not losing money on the arbitrage because I bought a lot of TIPS when rates were higher.

Is it really just purely a math question for you? I suspect for almost all of us, it's not just purely a math question. Behavorial economics teaches us that it's not all about math and that we humans place more weight on avoiding losses than generating gains. So, I wouldn't be so dismissive about people wanting to sleep better when their mortgage is paid off. Perhaps you're different from most of us, and perhaps if you won the lottery the last thing on your mind would be paying off that mortgage -- I know it would be the first thing that would run through my mind even if my interest rate were 1.85 % and math would dictate to hold on to that mortgage.

 

[FLJim]

Is it really just purely a math question for you? I suspect for almost all of us, it's not just purely a math question. Behavorial economics teaches us that it's not all about math and that we humans place more weight on avoiding losses than generating gains. So, I wouldn't be so dismissive about people wanting to sleep better when their mortgage is paid off. Perhaps you're different from most of us, and perhaps if you won the lottery the last thing on your mind would be paying off that mortgage -- I know it would be the first thing that would run through my mind even if my interest rate were 1.85 % and math would dictate to hold on to that mortgage.

Whether it's pure math or not I think depends on each one's life experiences. I was homeless in 1968 living in a paid-for $350 car. I guess that made me hate debt and appreciate liquidity. It turned out OK. We own a house in FL and a house in IN, 3 vehicles, everything paid for, and a NW north of 4MM. Debt is just not in my wheelhouse, and I didn't need it to get where I am.

 

[harley]

So, I wouldn't be so dismissive about people wanting to sleep better when their mortgage is paid off.

I don't think that most of us pro-mortgage people are at all dismissive about people that prefer a paid off house. If that's what makes you happy, drive on. But when someone asks for opinions on the subject I assume they'd like more than one. And when (as often happens) someone says having a paid off house is a no brainer, pointing out the fallacy of that statement is not only good civic responsibility, it's fun.

 

[bobandsherry]

Paying off a house sounds great, until you are house rich and cash poor. I have a family friend, just turned 80 and living on a small pension and Social Security, just barely above Medicaid cap. Somewhat unfortunate as he misses out on some possible assistance programs. Fortunately he live frugally.

Sure, he has a paid for house but has little in savings and should a medical or other tragedy strike he has little to dip into.

He's one of those are against having debt, but now at a point he can't borrow at a reasonable rate as he doesn't have the income to qualify. With little other options perhaps a reverse mortgage will be in his future. But I understand the fees on those are outrageous and the amount of equity they will pull out is rather dismal. Hopefully he continues to have the money to pay his real estate taxes just so he doesn't end up in tax foreclosure and lose his fully paid for place.

He's very rural so selling and renting isn't a real possibility and he's a stubborn SOB who just says he wants to live in HIS place.

Anyway, an example where having a low rate mortgage and a portfolio that was 2x the return could actually improve his cash flow situation and be better prepared for a tragic event.

 

[daylatedollarshort]

Is it really just purely a math question for you? I suspect for almost all of us, it's not just purely a math question. Behavorial economics teaches us that it's not all about math and that we humans place more weight on avoiding losses than generating gains. So, I wouldn't be so dismissive about people wanting to sleep better when their mortgage is paid off. Perhaps you're different from most of us, and perhaps if you won the lottery the last thing on your mind would be paying off that mortgage -- I know it would be the first thing that would run through my mind even if my interest rate were 1.85 % and math would dictate to hold on to that mortgage.

Yes, it is just a math question for some of us. That has been answered in this thread alone, many times, by myself and others.

Pointing out math facts is being logical, not dismissive. No one here has criticized people who don't have a mortgage, but if the reasons they don't have one are illogical or not supported by math, that has been pointed out.

 

[rayvt]

Asking the question a different way. If your house was now paid-for, free and clear, would you take out a mortgage and invest the proceeds??

Yes, if I could get a cash-out mortgage for the same cost (fees & rate) as a non-cashout mortgage.

Those of us who are serial refinancers are essentially doing this. Every time you refi you start a new 30 year period. We've been in this house for 15 years, but have 29 1/2 years to go on the mortgage. Have always just refi'ed the current balance, because nowadays they charge a lot if you take cash out-- including rolling a HELOC balance into the loan.

 

[rayvt]

Is it really just purely a math question for you? I suspect for almost all of us, it's not just purely a math question.

But realize that most of us here are very atypical. This group of people has the ability to easily pay off their mortgage. Most people cannot pay off their mortgage, because they don't have the money. Those are the people who have an actual sleep-well-at-night issue.

If you have enough money that you can easily pay off the mortgage, SWAN issues are mostly all in your head. First world problem.

 

[ERD50]

Is it really just purely a math question for you? I suspect for almost all of us, it's not just purely a math question. Behavioral economics teaches us that it's not all about math and that we humans place more weight on avoiding losses than generating gains. ...

And Behavioral Economics teaches us that placing more weight on avoiding losses than generating gains leads to incorrect decisions. And I don't mean preferences, I mean factually incorrect. So shouldn't we try to overcome that human trait (with information/education), and avoid the pitfalls?

https://www.nngroup.com/articles/prospect-theory/

Scenario 1: Participants started with $1000. They then could choose between:

A) Winning $1000 with a 50% probability (and winning $0 with a 50% probability), or
B) Getting another $500 for sure.

Scenario 2: Participants started with $2000. They then could choose between:

C) Losing $1000 with a 50% probability (and losing $0 with a 50% probability), or
D) Losing $500 for sure.

....

Note that the outcomes and odds for each scenario are exactly the same. For either A or C, you have a 50/50 of ending up with $2000 or $1000. For B or D, you end up with $1500.

... However, people made opposite choices in the two scenarios: the majority chose the risk-averse option B in Scenario 1 and the loss-averse option C in scenario 2.

Changing the framing of the problem (by adjusting the initial gift and the options accordingly) led people to a different decision.

There should have been no difference between the preference of A/B and C/D, but there was, because people weren't thinking straight.

Whether it's pure math or not I think depends on each one's life experiences. I was homeless in 1968 living in a paid-for $350 car. I guess that made me hate debt and appreciate liquidity. ...

You do realize that paying off the mortgage (hating debt) results in *less* liquidity?

I appreciate liquidity too, and have made the calculation that mortgage debt at these historically low interest rates is not something to hate. You can decide against it if you want, but I see no reason to hate it.

-ERD50

 

[gamboolman]

We paid our mortgage years ago - way before retirement...

For us, it was and has been the best decision.

Only you can answer what is right for you vs keeping the money in the market....

 

[daylatedollarshort]

But realize that most of us here are very atypical. This group of people has the ability to easily pay off their mortgage. Most people cannot pay off their mortgage, because they don't have the money. Those are the people who have an actual sleep-well-at-night issue.

If you have enough money that you can easily pay off the mortgage, SWAN issues are mostly all in your head. First world problem.

Many here likely have the ability to pay off their mortgage off many times over. The mortgage arbitrage is just a way to add a bit extra to the portfolio income.

 

[RobbieB]

If I had a 3% mortgage I wouldn't pay it off early. I paid off an 8% early though -

Yup pure math. But I'm not going to refi and buy equities either. House is 10% of net worth. Why bother?

 

[piccolopat]

Some like me like to have a piece of mind paying off a mortgage in that I don't owe anyone anything . No one has to understand how I feel.

I retired almost 3 years ago with a mortgage and now have about 3 1/2 years to go. Since I have the money to support paying it and a low interest rate, I decided to keep it rather than using ready cash to pay it off. For me, I just don't look at having no mortgage as being debt free because I will always have the large tax bill (debt to the government!) to pay. When the mortgage is paid off, I'll still have a substantial monthly payment that will go into a self-funded escrow account for taxes and insurance.

I believe that having the extra ready cash in case of a down market, in case an opportunity comes up or just fun money to spend on something we really want to do is more valuable for us. YMMV but this works for us.

One thing I sometimes wish I had done pre-retirement was take out a HELOC. We have a few home projects that we'd like to do. A HELOC would allow us to fund it over several years rather than withdraw from the tax deferred retirement funds all at once and pushing us into a higher tax bracket. Of course I hadn't found this site back then and didn't know what I didn't know. We'll just stagger the projects a bit so minimize the tax bite.

 

[SweetP]

Yes, if I could get a cash-out mortgage for the same cost (fees & rate) as a non-cashout mortgage.

Those of us who are serial refinancers are essentially doing this. Every time you refi you start a new 30 year period. We've been in this house for 15 years, but have 29 1/2 years to go on the mortgage. Have always just refi'ed the current balance, because nowadays they charge a lot if you take cash out-- including rolling a HELOC balance into the loan.

Better.com is currently offering me a 15 year, no cost refi with a $200k cash out for 2.125% and $2k credit through the Amex offer. I owe less than $50k on my current mortgage, but I am seriously considering doing this. I feel pretty confident I can make more than 2.125% on the money over 15 years.

 

[dcoy]

I retired almost 3 years ago with a mortgage and now have about 3 1/2 years to go. Since I have the money to support paying it and a low interest rate, I decided to keep it rather than using ready cash to pay it off. For me, I just don't look at having no mortgage as being debt free because I will always have the large tax bill (debt to the government!) to pay. When the mortgage is paid off, I'll still have a substantial monthly payment that will go into a self-funded escrow account for taxes and insurance.



I believe that having the extra ready cash in case of a down market, in case an opportunity comes up or just fun money to spend on something we really want to do is more valuable for us. YMMV but this works for us.



One thing I sometimes wish I had done pre-retirement was take out a HELOC. We have a few home projects that we'd like to do. A HELOC would allow us to fund it over several years rather than withdraw from the tax deferred retirement funds all at once and pushing us into a higher tax bracket. Of course I hadn't found this site back then and didn't know what I didn't know. We'll just stagger the projects a bit so minimize the tax bite.

You should be able to get a heloc, look around. Another option is a pledged asset line (PAL) through your brokerage.

 

[armor99]

For someone who is squeaking by or still in the savings/earning mode without a large emergency fund or accessible saving...ok, sure, stick with the 30.



But for the vast majority here, and for 100% of those for whom paying in full is an option, then a 15 year is a good middle ground if the rates are worth the bother of the refi.



The risk is about zero for this population.

Or… you can take the 30 year loan… and still pay it off as though it was a 15 year loan with extra principal payments.
That way you have a fall back position if needed.

 

[RetiredHappy]

You should be able to get a heloc, look around. Another option is a pledged asset line (PAL) through your brokerage.

Since piccolopat said that money needs to come out of tax deferred account for house projects, I would assume that taxable accounts are small. PAL can only be done against taxable accounts.

 

[GTFan]

Yes, it is just a math question for some of us. That has been answered in this thread alone, many times, by myself and others.

Pointing out math facts is being logical, not dismissive. No one here has criticized people who don't have a mortgage, but if the reasons they don't have one are illogical or not supported by math, that has been pointed out.

So all of us with a paid off house should immediately borrow to max LTV against our house, then invest the money (assuming ~3% loan)? Or take out a margin or pledged asset loan against the portfolio for as much as we can invest (and sleep) with because the interest rate is cheap?

Because that's the same logic, and yes by the math it makes sense. But it most definitely is not just a math question. It's whether you want to use arbitrage or not.