6 Mortgage Myths

[azanon]

Quote:

I don't see the comparison here at all. *A big difference between keeping a mortgage and margining stock investments is what you are betting on in each case(your house vs a specific stock). *You can evaluate the risk historically using FIRECALC and it's just not that great. *With a 5.5% or lower mortgage, your odds historically are that you are taking more risk by paying off the mortgage than be keeping it.

The comparsion is perfect, actually. *Seems like you think margin accounts can only be used to buy individual stock. *That's incorrect. * You can buy whatever you want with the borrowed money actually, including you guys beloved index funds. * And isnt that the real investment you're saying is so much better than paying off a loan first? *Or name one you like? *Yep, you can use a margin loan for that too. *Its almost a crime how easy a loan is to get.

Investing borrowed money is margining. *That's a fact, Jack. *Just because you have a loan over here, and an investment over there with a different name doesnt make it all of a sudden, not margining.

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That may sound like no-nonsense to you, but a hard stance against real-estate debt sounds incredibly nonsensical to me. *If every person and every business took that attitude, almost no one would ever own property. *You should do what you feel comfortable with, though.

David makes an exception for your own house, but even in that case, he advocates paying it off early. *One could do a lot worse than working towards paying off their debt. *David does thing debt is dumb for things besides your personal home, and champions several blue-chip businesses for refusing to go in debt.

.....

I think people are forgetting why banks and the like are willing to give you a loan anyway, of any type. Because they think they'll come out better in the end that you by lending you the money and you taking the risk for them. There is no win/win scenario with lender vs borrower. Risk and Reward is a balance scale, and when someone loans you money, they set the rate such that they think the scale will come out in their favor by the time its all said and done.

"...Walters advises people to imagine a scenario where they have a 5- percent ARM and are able to deduct the interest from their federal income taxes. That lowers their effective interest rate to somewhere in the neighborhood of 3.75 percent..."


Does this rate of return take the standard deduction
into consideration? One may be "paying" for a deduction that one would get "for free" anyway.








".. One could do a lot worse than working towards paying off their debt. .."



I intend to refinance my mortgage (currently less than
a third of the value) through my IRA , but it will be
about two years before I can meet the Dept. of Labor's
requirments for doing that. Then I will set up an interest-only adjustable rate note and pay my interest
into my IRA rather than to GMAC (who bought my note
from the last outfit that bought it.)



Capricious

[brewer12345]

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What I've been struggling with is whether I should be considering the effect of inflation when I do my payoff vs. not payoff analysis. *The dollars I would spend in the future to make the mortgage payments would have less purchasing power than the dollars I would spend today to pay off the mortgage. *But is that a relevant consideration? If inflation is running at, say, 2.3% wouldn't I just need to make another 2.7% on my investments to offset the 5% I'm paying on the fixed rate mortgage? *And if I'm able to itemize deductions on my taxes, the reduction in taxable income from the mortgage interest would exceed the increase in income from the 2.7% earnings on my investments. *That could be an added benefit. But maybe this is just voodoo economics? Thanks, Ish

Ish, I think there are two ways to look at the payoff decision. One, historically would you have been better off with the mortgage paid off given your resulting portfolio and income needs? I think FIREcalc can help you address this. The other, can you earn enough after tax on your marginal fixed income investments to come out ahead of the after tax cost of the mortgage? I suspect the answer here is no, but you would best be able to tell. If you can tell us what the remaining period on the mortgage is, what your marginal fixed income investemnt is, and what tax bracket you are in, we could probably help you figure the second bit out.

Personally, if I were you, I would probably take out a HELOC and then pay off the mortgage. That way you can pretty easily re-leverage if you need to, but in the mean time you have the mortgage off your back.

[sgeeeee]

Quote:

What I've been struggling with is whether I should be considering the effect of inflation when I do my payoff vs. not payoff analysis. *The dollars I would spend in the future to make the mortgage payments would have less purchasing power than the dollars I would spend today to pay off the mortgage. *But is that a relevant consideration? If inflation is running at, say, 2.3% wouldn't I just need to make another 2.7% on my investments to offset the 5% I'm paying on the fixed rate mortgage? *. . .

Hi Ish,

You're right. Since the mortgage payment is fixed, then the comparison you should make is to the absolute return. If your rate of return on investments is 6% with 6% inflation, you're real rate of return is 0% . . . but you are still ahead of paying off a 5% mortgage.

If we hit a spell of inflation, then the fixed mortgage is an almost guaranteed boom to your investments. That is precisely why a low rate mortgage has actually been a safer financial decision than paying off a house historically.

Of course no one can tell you for sure whether it will be true in the future, but people can analyze how they have done with their investment decisions. People who kept their sub 5.25% mortgage over the past several years are already likely ahead of where they would be had they decided to payoff their mortgage.

There is a lot of passion from some people about this decision and many seem to feel that they have to attack any ideas that suggests that the answer to the question might vary depending on mortgage rates and other economic conditions. People who feel that way should clearly pay off their mortgage. So should a lot of other people who are near the end of the loan terms or have high mortgage rates.

But as you can see from the original article posting, not everyone sees the situation that way. A dispassionate analysis of the numbers leads many knowledgeable people to a different conclusion. It is worth the time to do the analysis -- even if you decide that the numbers are not compelling for your situation.

FIRECALC can be used to look at this situation in detail. Run one simulation where you start with your initial portfolio reduced by the amount of your payoff and run the simulation for the length of the loan (for example 30 years if you just established a 30 year fixed loan). Run a second simulation that uses your full portfolio but that includes a regular annual payment for the amount of the 12 loan payments. You should compare the terminal values as well as the SWR from both simulations. This simulation will not include tax effects (positive or negative). If you want to include these, you will need to include the effects of tax deductible interest payments as well as taxes on any additional withdrawal required for the payments. My own experience is that the tax effects are of second order importance, but your tax situation could be different.

[sgeeeee]

TH,

You have given qualitative reasons to make comparisons on this issue a number of times. You decide how you want to compare things and state them as if they are rules. You are simply stating your opinion and clearly (as the article shows) your opionion is not shared by everyone. Why does this bother you so much?

Let me be specific. You state that paying off is a 5% guaranteed return. But you are making no guarantees for your real return over the next 30 years. If inflation were to jump to 5% with a 5% real return averaged over the next 30 years, then your payoff would have been a 0% real return move or a loss of 5% real return over 30 years. Historically, that is qualitatively what would have happened to anyone choosing the payoff option. You can come up with a quantitative historical result using FIRECALC. You may prefer not to analyze your mortgage situation like this, but many people do. The article clearly proves that there people who view the situation differently than you.

You also claim that the payoff is a risk free investment. But again, as the above example shows, that is only true if you only consider one kind of risk. There are other risks to home ownership too. Certainly, each person needs to establish their own risk profile. And that can be more important to an indivdual's decision than the fact that historically they would benefit from keeping a mortgage. Again, in your case, you have decided that the only way to compare mortgage and investment is using fixed income investments at today's rates. That clearly means that you should pay off your mortgage. I believe that you already have. You made the right decision for you. But as the article clearly shows, not everyone shares your view of risk. People who feel comfortable with the minimal risk of keeping a mortgage have been able to do very well in recent years. You feel that they are taking terrible risks, but they don't.

Let me point out, TH, that I was not the author of this article that I posted. Clearly there are people who look at the mortgage payoff differently than you. So let me also point out that it is you that continues to take the inflexible position. Our continuing discussion on this issue runs like this:

SG: Mortgage payoff is not a black and white issue. Historically, keeping a low interest loan with a balanced investment portfolio can result in both an increased SWR and increased terminal value. The investment results are only one aspect of this decision, but it is probably worth it to look at the numbers before you follow blind, inflexible advice.

TH: No, you're wrong. I don't trust historical results and I think it's risky. The only decision anyone should ever make is to payoff your mortgage.

I'm only kidding. (See the little smiley.) Actually, although I had difficulty reading through your whole post, I appreciate that your final paragraph showed much balance.

[cute fuzzy bunny]

Perceptions are funny arent they?

I was starting to think you're trolling me for bringing this much beaten dead horse up so often.

I've ALWAYS said that everyone should do their own math. I've even on occasion presented scenarios in support of both decisions. So far I've never seen you air a scenario that isnt pro-mortgage, although you do give lip service to "do your own math".

I've only stated facts as facts, and tried not to muddy the water or use extreme examples. For example, calculating this as a 30 year scenario when hardly anyone in the US stays in a home for more than 10 years. Or fudging in mortgage interest savings without factoring in income tax on the increased withdrawal.

I didnt read the article, but I'm betting the writer had non retirees in mind, and I agree with him if thats the case. If you're drawing a big salary and paying a lot of income tax, pulling a mortgage and putting your money into the stock market makes a world of sense. If you're increasing your withdrawal rate 30-50% to pay a mortgage, and you're paying taxes on that increased withdrawal, and support of that higher withdrawal is dependent on after tax rates of stock return that are higher than 5-6%, then I question that decision.

If you're retired and have a substantial heap of money and investments, and you're paying 5-6% on a mortgage (the national average right now), while making 3-4% on a similar amount of bonds, you're crazy. Thats a fact. 5>4. 5>3. 6>4. 6>3.

Azanons point is quite valid. If you're issuing a bond to the bank with your house as collateral, and then using the free cash gained from the bond to invest in the stock market, you're investing on margin. Gambling. Historically over a 30 year period, that is a winning proposition. Thats a fact. Historically over a 10 year period, its not always so. Thats a fact. In the meanwhile, if you're using part of that gain to buy bonds or bond funds, you're losing money in the arbitrage. Thats a fact. But investing in stocks and keeping a bond on your home is far riskier than not. Thats a fact. Therefore, comparing paying off a mortgage to investing in stocks is not an equal comparison. Thats a fact.

If you want to put the mortgage money in the market and hope that the expected average annual 6-8% pretax earnings beats your mortgage, and that risk feels good to you, then do it. But thats an opinion on where the future markets are going. Considering Morningstar has the overall market 12% overvalued, and that is the highest its been since early 2000...I wouldnt want to make that bet right now.

If you can find a low risk instrument that gets you a quarter or half percent after taxes to offset your mortage and squeak a few dollars out of that arbitrage, then do it.

However, it is my OPINION that for most ER's with a large investment portfolio and a mortgage, they'd probably be better off paying the mortgage from their bond portfolio and reducing their SWR. I ran those numbers for myself, and I've posted a lot of reasonable scenarios using firecalc that showed that in the vast majority of cases you're better off without the mortgage. In fact, I proposed a scenario where someone without a mortgage can retire on $100k less than someone with one, maintaining the same lifestyle. With no more or less risk than having the mortgage, according to the historic numbers you rely on.

So what we're saying is we'd rather have to get more money before retiring, then put a home and the portfolio at considerable increased risk in hopes of ekeing out a marginally higher long term rate of return? I'm afraid I've misjudged this whole thing, because that just sounds way too enticing for me to pass up. Fortunately its monday and my credit union is open so I can call them up and get me a mortgage.

As far as calling in the risks of homeownership and saying that paying off the mortgage is not risk free...well, you have those risks with or without a mortgage, there is no difference. Hence they cancel on either side of this equation. Unless you want to suggest that you might default on the mortgage if something bad happened to home values or godzilla steps on your house. You can also always take out a mortgage. You can also hold a HELOC like I do, just in case. More muddying of the waters...

May I propose that the reason you keep bringing it up is because you're uncomfortable with your own decision and are looking for some support and validation, rather than some problem with my reasoning?

[cute fuzzy bunny]

Quote:

What I've been struggling with is whether I should be considering the effect of inflation when I do my payoff vs. not payoff analysis. The dollars I would spend in the future to make the mortgage payments would have less purchasing power than the dollars I would spend today to pay off the mortgage. But is that a relevant consideration? If inflation is running at, say, 2.3% wouldn't I just need to make another 2.7% on my investments to offset the 5% I'm paying on the fixed rate mortgage? And if I'm able to itemize deductions on my taxes, the reduction in taxable income from the mortgage interest would exceed the increase in income from the 2.7% earnings on my investments. That could be an added benefit. But maybe this is just voodoo economics? Thanks, Ish

Inflation has different effects. Essentially for a retired person you dont need to compensate for inflation to pay the mortgage. For someone drawing a paycheck, which indexes upwards faster than inflation (on average), a mortgage payment smells pretty good after 15 years when its still the same amount as it was originally, while your take home pay has gone up 2-3% a year.

In the latter case, consider your paycheck a zero value bond that generates your annual salary as a dividend, inflation adjusted, while the mortgage is a sliding value bond you issue to the bank and pay a fixed dividend to (the interest rate), callable by you, non inflation adjusted.

[haha]

Quote:

Seems like you think margin accounts can only be used to buy individual stock. *That's incorrect. * You can buy whatever you want with the borrowed money actually, including you guys beloved index funds. * And isnt that the real investment you're saying is so much better than paying off a loan first? *Or name one you like? *Yep, you can use a margin loan for that too. *Its almost a crime how easy a loan is to get. Investing borrowed money is margining. *That's a fact, Jack. *Just because you have a loan over here, and an investment over there with a different name doesnt make it all of a sudden, not margining. <snip> I think people are forgetting why banks and the like are willing to give you a loan anyway, of any type. *Because they think they'll come out better in the end that you by lending you the money and you taking the risk for them. *There is no win/win scenario with lender vs borrower. Risk and Reward is a balance scale, and when someone loans you money, they set the rate such that they think the scale will come out in their favor by the time its all said and done.

Azanon, if I understand you, you are saying that a home mortgage is functionally equivalent to a margin loan.This assertion is flawed on several counts. One, you can't fix the rate on a margin loan while you can on a home mortagage loan. Two, a home loan is only callable in a few instances-eg, you sell the house, or you fail to make a certain number of timely payments. As long as the physical collateral (your home) still exists, it doesn't matter what its market value is, your loan cannot be called. Not so with a margin loan. That is why experienced people have a healthy respect for margin calls.

Additionally, there are safeguards for mortgage borrowers on a primary residence, for example rules about forclosure. Ask anyone who got caught with margin debt in the 1987 equity downturn how fair a deal he thinks he got from his broker/lender.

Your second point, about how the lender and borrower cannot have a win-win deal is also flawed because you evidentally have forgotten or do not know that there is third party to this tranaction in most cases. The lender merely originates the loan, and then sells it to any number of repackagers, who then resell in securitzed form to individuals and instituions who for whatever reason want securities with these characteristics. These low interest loans are hot-potatoes. Without the ability to pass them on, most would never be made, at least by a banker older than 30.

But with securitization the originator can benefit from fees and the borrower can benfit from a low cost loan. Truly a win-win.

Mikey

[cute fuzzy bunny]

Mikey - you're arguing fine points. Azanons point is that they ARE functionally equivalent where it matters, and I agree. You're borrowing money at one rate for investment purposes in the hopes that your investment returns will exceed the borrowing rate.

However your points on the increased risks and issues associated with borrowing on margin are well taken.

As far as mortgages callability...you might go back and re-read the fine print on yours. If there is no clause that allows the mortgage company to "call" your mortage, then its a rare one. Many mortgages do in fact allow the mortgage company to bail on you. That its done infrequently is why most people arent aware of it.

The reasons for enabling a cancellation are varied, and the time frame before cancellation becomes effective is usually plenty to get a replacement mortgage.

Well I'm really glad I paid off my 9 year 5.25% Motgage last year. Yes it saved me a few bucks as my portfoilio is only up about 3.4% this year.

But the real reason, is I hate people telling me what to do. As long as there is a string attached to your house (debt) - There always seems to be paperwork arriving in my mailbox telling me which Hoop I have to jump through.

I'm 53 years old and sick of jumping through hoops!

[cute fuzzy bunny]

Wanna send me all your old hoops then so I can jump through them until I'm sick of it?

Quote:

Wanna send me all your old hoops then so I can jump through them until I'm sick of it?

TH,

You mean you didn't have to jump through hoops at your former employer?

- One more sexual Harrassment training seminar would have put me in the funny farm.

[cute fuzzy bunny]

They didnt send me to any of those. Apparently I was already good enough at it to not warrant it

[Bob_Smith]

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But the real reason, is I hate people telling me what to do. As long as there is a string attached to your house (debt) - There always seems to be paperwork arriving in my mailbox telling me which Hoop I have to jump through. I'm 53 years old and sick of jumping through hoops!

Cut-Throat, we paid off our mortgage years ago. In view of the thoughtful analysis provided on these pages by both TH and SG, I'm ashamed to admit why we paid it off, but I will anyway...

We were paying 9%, which was higher than the going rate at the time; we were busy and it just got away from us. One of the bank's loan officers got snotty with my wife over a small fee they tried to add to a savings account that was set up to receive our mortgage payments. So we paid off the mortgage in full - just for spite.

A bank VP called and tried to dissuade us, and he forced that snotty loan officer to call and apologize, etc. I never did the math, but if we did lose money, it was worth every penny. If there was a contest for the dumbest reason to pay off a mortgage, we'd be serious contenders.

[haha]

Quote:

Mikey - you're arguing fine points.

TH, mea culpa. I apologize to you and anyone else who feels this way. I just can't help myself from being more interested in demonstrable facts than blanket assertions.

But I really cannot see how the difference between a floating margin loan and a fixed mortgage can be called a fine point. If so, the difference between a man and a woman is a fine point. After all, the margin loan and the mortgage loan are both loans, and a man and a woman are both people. And the other things I said are simple facts, that were ignored by the original poster. Whether they are important differences or fine points I think might depend more on the situation of the borrower, rather than on your opining one way or the other.

I wonder too if you may feel that readers of this forum can't make up their own minds about what is meaningful and what isn't, without being told by TH. As helpful as you are on many topics, I imagine that as ERs they probably are capable of that task on their own. In fact, I would even expect as experienced men and women of the world, most of us probably already know much of the broad aspects of many of these topics. What is left are details. Or we can just ignore data and argue.

I also have doubts about what you assert is the callability of home mortagage loans, absent nonperformance on the part of the borrower. I am not a real estate attorney, so I really can't comment on when this might be true. If you can supply some instances of what you are talking about, I and possibly many others would be very interested in these "details".

However, it seems to me that if your idea on this were broadly true, we would never have experienced the S&L breakdown of the 80s. The banks that could no longer fund their 7% mortgages except at a loss would just call the loans. If fixed loans were callable in the sense that you are suggesting, what is the difference between a fixed and a floating rate home loan? Why would anyone take a fixed loan? Why in fact are they called fixed loans?

Mikey

[BigMoneyJim]

Quote:

So we paid off the mortgage in full - just for spite.

I think that's the best reason for paying off a mortgage I've heard yet.

Please allow me a little repetition.

I never really did the math for our situation, but
I believe I could come up with reasons to go either
way (pay off vs. keeping a mortgage). We carry no mortgages on any
of our real estate (50% of net worth). It keeps things simple and helps to protect me from myself in making the
cash a little harder to access, if only psychologically.
Taxes are not a factor with me as I pay no federal income taxes at any level.

John Galt

[cute fuzzy bunny]

Quote:

TH, mea culpa. I apologize to you and anyone else who feels this way. I just can't help myself from being more interested in demonstrable facts than blanket assertions. [...more hostile blah blah]

Gee mikey, I thought I was pretty nice in my response to you, since we were talking about the analogy in terms of borrowing money to invest...which a margin loan and taking out a mortgage to invest both are. I said your points were well made, but in fact they had nothing to do with that core point. They almost seemed argumentative rather than adding anything to the discussion.

As far as the rest of your rant, I'm not sure where you're coming from or what your problem is. I certainly dont need your hostility when I havent been hostile to you. So shove it back into your pampers and keep it, m'kay?

[haha]

Quote:

*So shove it back into your pampers and keep it, m'kay?

Sorry big guy. But I reread my post and I can't see anywhere that I veered from the topic at hand. OTOH, your hostility, or need to prevail, is written all over your post as is pretty clear by the invective above quoted.

[sgeeeee]

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I think that's the best reason for paying off a mortgage I've heard yet.

I agree, Bob. If I could pick the person my payoff would spite, I would pay it off tomorrow . . . and maybe the day after too.