Change in Mortgage Thinking in Retirement

[rayvt]

So try this example from pb4uski, if he paid off his mortgage with his cash and losing bond funds, would his total return improve? It's basic arithmetic right?

If he did that, what he's really doing is both paying off the mortgage from his assets AND simultaneously changing his asset allocation.

In determining how your morgate rate compares to your portfolio return, you have to view the ENTIRE portfolio, not just one piece of it. That's the error you are making.

If I had a $100,000 mortgage, and my portfolio AA was $100,000 cash, $600,000 stocks and $300,000 bonds, then I have evidently chosen to have a 60/30/10 asset allocation. Presumably because I wanted to have a high allocation to risk-free cash.

Why would I suddenly change my risk tolerance and change my AA to 67/33/0 at the same time as paying off the mortgage?
Paying off the mortgage and changing the AA are two independent decisions. If I wanted to be at 67/33/0 I would just do it. The decision to pay off the mortgage is a different decision.

 

[corn18]

Freedom has it all figured out. Just acknowledge that and this thread can end.

Over/under is 25 pages.

 

[flintnational]

.............One such bogus reason is the claim that paying off the mortgage is equivalent to a guaranteed return at the mortgage rate. It's not, of course. If it was then we'd all be bragging that we were getting a guaranteed 25% return when we pay off our credit card balance every month. Or when we cancel a card with a 25% interest rate.

The credit card example is apples and oranges. The individual is actually having to pay the mortgage interest but as you state, they are not paying interest on the credit cards.

Assuming one has the funds to pay the mortgage off, there are two choices discussed in this thread. Pay the note off or invest the money and pay the note from the investment returns. Paying the note off will yield the same result as investing the money at a rate comparable to the mortgage rate and then paying the note. Therefore paying the note off guarantees the return will be equal to the mortgage interest rate. Its a relative comparison. Relative to the two choices above.

 

[mrWinter]

Going all the way back to the OP:

All retirement calculators say we are good to carry our mortgage for an infinite number of years.

Can we confirm or deny this claim? And can we use our simulation tools to help test out some of the arguments? I was also in the "equities return more than a mortgage costs, so better to keep the mortgage and invest in equities long-term" camp, but today I started trying to simulate that in a couple retirement calculators, and the results seem contrary to what I expected, and not in agreement with the OP statement above. Likely I have some assumption wrong or am using the tools wrong. Please correct me if so.

Here's what I'm inputting to firecalc.

I'm using the Other Income section to simulate a 100,000 mortgage loan at 15 years. Maybe this is the last 15 years of a larger loan, or maybe they refi right at retirement, either way the principle should be the same I figure. I'm just using google's mortgage calculator (just search for 'mortgage calculator' in google and you get a basic one right in the search results) to get the monthly rate then multiplying by 12 for the yearly cost, which equals 8832 for a 100k loan.

Comparison A:
Simulation 1 - 1 mil portfolio, 30k base spending, plus a 100k mortgage payments for the first 15 years. All defaults except:
Start Here -> Spending: 30000
Start Here -> Portfolio: 1000000
Start Here -> Years: 40
Other Income/Spending -> Off Chart Spending: 8832 starting in 2018
Other Income/Spending -> Pension Income (spending reduction): 8832 starting in 2033

Success rate: 96.3%

Simulation 2 - 900k portfolio (100k was removed from portfolio to pay down loan), 30k base spending, no mortgage payments . Same as above except:
Start Here -> Portfolio: 900000
Other Income/Spending -> Off Chart Spending: 0 starting in 2018
Other Income/Spending -> Pension Income (spending reduction): 0 starting in 2033

Success rate: 100%


Comparison B - higher base spending, lower success rate
Simulation 3 - 1 mil portfolio, 40k base spending, plus a 100k mortgage for the first 15 years. All defaults except:
Start Here -> Spending: 40000
Start Here -> Portfolio: 1000000
Start Here -> Years: 40
Other Income/Spending -> Off Chart Spending: 8832 starting in 2018
Other Income/Spending -> Pension Income (spending reduction): 8832 starting in 2033

Success rate: 70.1%

Simulation 4 - 900k portfolio (100k was removed from portfolio to pay down loan), 40k base spending, no mortgage payments. Same as above except:
Start Here -> Portfolio: 900000
Other Income/Spending -> Off Chart Spending: 0 starting in 2018
Other Income/Spending -> Pension Income (spending reduction): 0 starting in 2033

Success rate: 71.0%

Comparison C - initial base spending, but larger mortgage
Simulation 3 - 1 mil portfolio, 30k base spending, plus a 200k mortgage for the first 15 years. All defaults except:
Start Here -> Spending: 30000
Start Here -> Portfolio: 1000000
Start Here -> Years: 40
Other Income/Spending -> Off Chart Spending: 17652 starting in 2018
Other Income/Spending -> Pension Income (spending reduction): 17652 starting in 2033

Success rate: 82.2%

Simulation 4 - 800k portfolio (200k was removed from portfolio to pay down loan), 30k base spending, no mortgage payments. Same as above except:
Start Here -> Portfolio: 800000
Other Income/Spending -> Off Chart Spending: 0 starting in 2018
Other Income/Spending -> Pension Income (spending reduction): 0 starting in 2033

Success rate: 93.5%


In all three comparison scenarios the portfolio that paid off the mortgage fared better than the portfolio that carried a mortgage. This is not what I expected. Am I making any incorrect assumptions? Is my math wrong somewhere? Anything else I'm doing wrong to not accurately reflect the scenario? If not, then firecalc seems to be making the argument that paying off the mortgage is the historically better play.

Can someone come up with a firecalc simulation that suggests keeping the mortgage is better?

 

[corn18]

When I run the Flexible Retirement Planner with and without paying off the mortgage, it says keeping the mortgage is better. The issue is how I made the input to pay off the mortgage. I am 3 years from ER, so I would have to pull $400k from savings to pay off the mortgage (20% of my portfolio). That incurs a serious sequence of returns penalty. If I keep my mortgage, the SOR risk is greatly reduced and the monte carlo simulators like that.

 

[CRLLS]

I ran Fidelity's Retirement Planner.

If I delete the mortgage payment and replace it with a one-time expense to pay off the mortgage, I end up with 6% higher assets at the end of plan(age 100). I know that the % will vary depending on a lot of variables. But I was surprised too. I expected that the ending balance would be lower and paying off the mortgage as just a feel-good, risk avoidance effort.

 

[Texas Proud]

Freedom has it all figured out. Just acknowledge that and this thread can end.

Over/under is 25 pages.

I am taking over unless porky come calling....


And that is a stretch as usually these peter out long before then...

 

[COcheesehead]

I ran Fidelity's Retirement Planner.

If I delete the mortgage payment and replace it with a one-time expense to pay off the mortgage, I end up with 6% higher assets at the end of plan(age 100). I know that the % will vary depending on a lot of variables. But I was surprised too. I expected that the ending balance would be lower and paying off the mortgage as just a feel-good, risk avoidance effort.

Because you eliminate the interest expense. I did the same thing. To me it was a no brainer to pay it off. Everybody's situation is different.

 

[ERD50]

....

In all three comparison scenarios the portfolio that paid off the mortgage fared better than the portfolio that carried a mortgage. This is not what I expected. Am I making any incorrect assumptions? Is my math wrong somewhere? Anything else I'm doing wrong to not accurately reflect the scenario? If not, then firecalc seems to be making the argument that paying off the mortgage is the historically better play.

Can someone come up with a firecalc simulation that suggests keeping the mortgage is better?

I think there are a couple things:

First, may I suggest that rather than 'success rate', you use the investigate tab, and either adjust spending or adjust initial portfolio for 100% success. The reason is "quantization" - a $2 difference will take you from success to failure, but $2 isn't meaningful. Spending and/or initial portfolio won't be quantized like that, it will move smoothly, and give a better relative merit.


Second, I think (not certain, need to dig deeper into your numbers), that your analysis ignores the fact that the principal payments on that mortgage payment is not 'spent', it becomes part of your net worth. IOW, those payments didn't all go 'poof', only the interests did.

edit/add: hmmm, maybe that's a wash? In the pay-off case, the full equity is in the home, in the mortgage case, you end up with the full equity in the home - a wash?

Can you provide links to each analysis, that makes it easier to check. I'm also thinking (not sure), that 15 year may be a harder case than a30 year, since shorter runs of the market will have more cases of lower returns. It would also be helpful to see averages for portfolio or spend. I think most of us are saying there is a chance that the market may under-perform a low rate mortgage, but we feel the odds are too good to pass up, and we have enough buffer to not be too worried. If someone doesn't want to take what is likely a small risk, that's fine and reasonable. Just don't condemn the whole thing based on the corner cases.
​

Does that make sense?

further edit/add: I think I do have some examples of firecalc runs that shoe the advantage of a mortgage, and I will try to dig them up. But these were challenged, since that is going to include the high inflation of the 80's, when you couldn't get a 3% or 4% mortgage (or even a 13% or 14% mortgage!). So I have to agree that FIREcalc might not be the best tool for this.
​

-ERD50

 

[flintnational]

...............[/B]In all three comparison scenarios the portfolio that paid off the mortgage fared better than the portfolio that carried a mortgage. This is not what I expected. Am I making any incorrect assumptions? Is my math wrong somewhere? Anything else I'm doing wrong to not accurately reflect the scenario? If not, then firecalc seems to be making the argument that paying off the mortgage is the historically better play.

Can someone come up with a firecalc simulation that suggests keeping the mortgage is better?

I think I have an answer (maybe). But will yield to those that know Firecalc better than I.

Firecalc is showing survival percents as you show in your post. When the survival percents go up or down, it is because the "worst" 30 year periods are coming in to play or being removed from a given scenario. The worst periods are defined as periods that have the lowest 30 year return. In these periods, yes it would have been better to have paid off the mortgage (of course this is rate dependent). But, these were the worst periods. Most that are keeping a mortgage and investing the money are assuming average stock and bond returns. Firecalc is not looking at average returns to construct survival rates but whether the worst periods will come into play. If you assume average investment returns it will show that keeping the mortgage will yield a better result. (once again, this is rate dependent)

 

[ERD50]

I think I have an answer (maybe). But will yield to those that know Firecalc better than I.

Firecalc is showing survival percents as you show in your post. When the survival percents go up or down, it is because the "worst" 30 year periods are coming in to play or being removed from a given scenario. The worst periods are defined as periods that have the lowest 30 year return. In these periods, yes it would have been better to have paid off the mortgage (of course this is rate dependent). But, these were the worst periods. Most that are keeping a mortgage and investing the money are assuming average stock and bond returns. Firecalc is not looking at average returns to construct survival rates but whether the worst periods will come into play. If you assume average investment returns it will show that keeping the mortgage will yield a better result. (once again, this is rate dependent)

Agreed. I touched on that in my previous post, just went back and bolded it to highlight what you are saying.

-ERD50

 

[flintnational]

Agreed. I touched on that in my previous post, just went back and bolded it to highlight what you are saying.

-ERD50

I think I was typing while you were posting.

 

[Freedom56]

What a shocker? If you pay off your mortgage, you actually come out ahead. If you keep your mortgage and invest, the asset manager comes out ahead. Some people are finally figuring out that you can actually invest the monthly P&I that you save after payoff.

 

[Freedom56]

Because you eliminate the interest expense. I did the same thing. To me it was a no brainer to pay it off. Everybody's situation is different.

Of course it's a no brainer to pay it off. The only scenario where it makes senses to keep one is when the mortgage rate is below your lowest performing asset class or in the case of rental rental properties where the renter is paying the debt indirectly through his/her monthly rent.

 

[flintnational]

I am trying for the elusive "Forum Member of the Month" award. And I wanted to use the new emoji!

 

[USGrant1962]

When I run the Flexible Retirement Planner with and without paying off the mortgage, it says keeping the mortgage is better. The issue is how I made the input to pay off the mortgage. I am 3 years from ER, so I would have to pull $400k from savings to pay off the mortgage (20% of my portfolio). That incurs a serious sequence of returns penalty. If I keep my mortgage, the SOR risk is greatly reduced and the monte carlo simulators like that.

This sounds backwards to me. In a bad SORR case your portfolio drops early in retirement. If you keep the mortgage you are leveraging your portfolio (putting more in the market) and you will lose more money than a payoff case - and will still owe the balance of the mortgage from your reduced portfolio.

Paying off a mortgage reduces SORR, not increases it.

Keeping a mortgage in favor of your portfolio is leveraging for both good and bad cases.

 

[ERD50]

What a shocker? If you pay off your mortgage, you actually come out ahead. ... .

Now there's some cherry picking for you. And it doesn't even conflict with anything we are saying ('we' being the people trying to provide information on the issue, rather than ideology).

What it may show (I haven't fully reviewed it yet, and I did mention why FIREcalc might not be the best tool for this), is that (and this is not a shocker!), that sometimes, holding a mortgage might not be a positive. Like if your balanced portfolio doesn't return more than the mortgage rate over a specific 15 year period.

An of course it's not a shocker, because none of us said it would always be so, just that on average, with a low rate mortgage, the odds are so good, that many of us don't want to pass it up.

If you were being honest, and actually trying to help people, you could have said:

If you pay off your mortgage, you might actually come out ahead, if the long term market is poor, or you have a high rate mortgage. ...
​

And then, you could provide some data, to show how often that might happen.

... If you keep your mortgage and invest, the asset manager comes out ahead. ... .

What asset manager?

... Some people are finally figuring out that you can actually invest the monthly P&I that you save after payoff.

And some people have figured out that with a mortgage, you can actually invest the entire mortgage amount for the long term.

Of course it's a no brainer to pay it off. The only scenario where it makes senses to keep one is when the mortgage rate is below your lowest performing asset class or in the case of rental rental properties where the renter is paying the debt indirectly through his/her monthly rent.

It is rarely a no-brainer, and it is an insult to forum members to imply they have no brains.

We've already discussed the idea behind a long term, balanced portfolio and looking at long term returns, not trying to dissect it and compartmentalize it. Money is fungible. But you don;t want to listen. Fine.

But to your last line - there is no way that the source of the funds affects the pay-off or not decision. The income is income either way.

-ERD50

 

[CRLLS]

Because you eliminate the interest expense. I did the same thing. To me it was a no brainer to pay it off. Everybody's situation is different.

But "traditional wisdom" has said you will lose the interest earned on a similar amount, making it more a comparison of interest earned vs interest paid. I wonder if it has more to do with the difference in years of mortgage left and years to the end of one's "plan"?

 

[mrWinter]

I noticed that I had the 'inflation adjusted' options checked (the default) for both of my entries on the Other Income/Spending tab, which I believe was an error, as a mortgage payment doesn't change with inflation. Nod to kite_rider who made mention of this:

The thing no one seems to bring up is that there is an 'inflation risk' to paying down mortgage debt. What if inflation jumps to 4%, or 8%?!? You would be really bummed that you paid off that 3.3% debt. That is what is keeping me from paying off the mortgage now...

Interesting to note that this does apparently make a significant difference.

Second, I think (not certain, need to dig deeper into your numbers), that your analysis ignores the fact that the principal payments on that mortgage payment is not 'spent', it becomes part of your net worth. IOW, those payments didn't all go 'poof', only the interests did.

edit/add: hmmm, maybe that's a wash? In the pay-off case, the full equity is in the home, in the mortgage case, you end up with the full equity in the home - a wash?

Good thought, but I think I agree with your edited conclusion, it's a wash. After 15 years in both scenarios you have a house with full equity. You either paid all principal down up front, or you paid it over 15 years (plus interest).

Can you provide links to each analysis, that makes it easier to check.

I did not know I could do that, how useful! Links below for inputs updated per discovery that I had incorrectly left the 'inflation adjusted' option selected. Very interesting to see that now the compared scenarios show an identical success rate.

First, may I suggest that rather than 'success rate', you use the investigate tab, and either adjust spending or adjust initial portfolio for 100% success.

I've also noted the results of the 'Investigate' tab as suggested as well to provide more info.

Interesting results here, it's almost an exact wash. This makes me wonder, this feels right at a big-picture macro economic scale. Did we really think the banks were getting a raw deal by offering us a loan, and we were coming out ahead? Seems unlikely.

Comparison A:
Simulation 1 - 1 mil portfolio, 30k base spending, plus a 100k mortgage payments for the first 15 years. All defaults except:
Success rate: 100%
Spending rate for 100% success: 30,049


Simulation 2 - 900k portfolio (100k was removed from portfolio to pay down loan), 30k base spending, no mortgage payments . Same as above except:
Success rate: 100%
Spending rate for 100% success: 30,072


Comparison B - higher base spending, lower success rate
Simulation 3 - 1 mil portfolio, 40k base spending, mortgage for 15 years
Success rate: 71.0%
Spending rate for 100% success: 30,049


Simulation 4 - 900k portfolio (100k was removed from portfolio to pay down loan), 40k base spending, no mortgage payments. Same as above except:
Success rate: 71.0%
Spending rate for 100% success: 30,072


Comparison C - initial base spending, but larger mortgage
Simulation 5 - 1 mil portfolio, 30k base spending, plus a 200k mortgage for the first 15 years. All defaults except:
Success rate: 93.5%
Spending rate for 100% success: 26,694


Simulation 6 - 800k portfolio (200k was removed from portfolio to pay down loan), 30k base spending, no mortgage payments. Same as above except:
Success rate: 93.5%
Spending rate for 100% success: 26,730


Wondering how this holds for different mortgage rates, I ran comparison C with some higher interest rates. Perhaps as expected, as interest rates rise, the benefit tilts toward paying it off.

Simulation 7 - initial base spending, large mortgage, 6% mortgage rate
Success rate: 89.7%
Spending rate for 100% success: 25,703

Simulation 8 - initial base spending, large mortgage, 10% mortgage rate
Success rate: 79.4%
Spending rate for 100% success: 22,676


Seems to be tilting the argument towards paying it off for me. Even in historically very low interest rate environments it's about a wash holding the mortgage vs paying it off. In higher rate environments it is beneficial to pay it off.

 

[mrWinter]

One caveat to the above simulations, I'm not taking into account the mortgage interest tax deduction, which I believe reduces the effective interest rate of the mortgage. Maybe lowering it just under the break even point in the recent low interest rate environment. I guess I could try and figure that in by just simulating with a lower interest rate but I'm not sure how well I could quantify that, and that option is only beneficial to some, fewer this year due to the updated tax laws.

 

[COcheesehead]

But "traditional wisdom" has said you will lose the interest earned on a similar amount, making it more a comparison of interest earned vs interest paid. I wonder if it has more to do with the difference in years of mortgage left and years to the end of one's "plan"?

Of course. It's how many years to get your payback. Once your payments are done, you start the payback process. The quicker the mortgage is paid off and the longer you live, the more the payback.

For me the decision was even easier. I am building a new house. The interest rates have increased a lot over what I had on my current house. I would have to take on even more risk assets in retirement to "beat" the new rate. Not wanting or needing to take that on after FIRE.

 

[COcheesehead]

One caveat to the above simulations, I'm not taking into account the mortgage interest tax deduction, which I believe reduces the effective interest rate of the mortgage. Maybe lowering it just under the break even point in the recent low interest rate environment. I guess I could try and figure that in by just simulating with a lower interest rate but I'm not sure how well I could quantify that, and that option is only beneficial to some, fewer this year due to the updated tax laws.

The mortgage deduction went away for many, including me. Another strike against carrying the mortgage.

 

[ERD50]

I ...

Interesting results here, it's almost an exact wash. ... .

Yes, thanks for those updates and the effort - now we just need to add some context to that.

Recall, this is showing you the spending level you can support in the worst financial environment in history for this profile, and still 'succeed'.

So if keeping the mortgage is pretty much a wash in the worst case, and it provides a better outcome in the majority of cases, that makes it pretty attractive to all but maybe the most extremely risk-adverse among us.

So let's look at averages as well:

Your case 1; 1 mil portfolio, 30k base spending, plus a 100k mortgage payments for the first 15 years:

$8,924 to $13,133,213, with an average at the end of $3,142,438

Your case 2; 900k portfolio (100k was removed from portfolio to pay down loan), 30k base spending, no mortgage payments .

$12,476 to $12,499,040, with an average at the end of $3,019,037.

Not a huge difference in average. I think you'll see a bigger delta with a 30 year mortgage, I mean that was really what some of us were saying - with historically low mortgage rates we've had recently, lock it in as long as you can. And rates a few years back were lower than the 3.92 you used. Obviously, the lower the better. My ARM has been down around 2%, and is still 3.125%.

It's probably time I repeat what I've said all along with this subject:

Whether you pay off or keep a mortgage (assuming a good interest rate), it probably is not a huge deal overall. My frustration has always been at the people who claim that paying off the mortgage was so very important, (edit for clarity) or claim it is a no-brainer for everyone and every case, or that "no one should retire with a mortgage", or the weird claims of benefits of losing that monthly payment with no acknowledgment of the benefit of having the money in your portfolio - available to invest or for liquidity.

Or that their house is safer w/o a mortgage - that could be the opposite. You still have property tax, utilities, maintenance, etc. If you lose your job, and paid off the mortgage, that money is harder to get to. Having $100,000 in liquidity will pay the mortgage and all your other bills ( food, car, etc), for years while you find a job. Some people have paid down their mortgage and didn't even have an emergency fund left, they were so afraid of debt. Now that can get you in trouble.

But avoiding extremes, no big deal. So don't try to make one of it!

-ERD50

 

[Freedom56]

Seems to be tilting the argument towards paying it off for me. Even in historically very low interest rate environments it's about a wash holding the mortgage vs paying it off. In higher rate environments it is beneficial to pay it off.

I'm not surprised by the results. I had this discussion with a financial adviser I know (not his client) back in 2005 when I was in the process of paying off the balance of my mortgage. He stated that I had too much equity in my home, it's dead money, and that I should re-finance and pull the cash out and invest it in the market. The markets, he said will outperform in the long run. I pointed him back to the 2000 stock bubble collapse. He stated is not likely to happen again. He stated that he was pulling $600K out of his home and investing it with Fisher Investments. He was getting a hand picked portfolio of stocks that would be managed. Ken Fisher, he told me got is clients out of stocks before the 2000 stock market bubble collapsed. Well things didn't work out that well for him. In 2008/9 some of the hand picked stocks literally evaporated. Others such as Citigroup and AIG became zombie stocks. He still has not recovered his money after all these years. I see him once in a while. He is depressed, divorced, and the only thing that worked out for him financially was the appreciation of his home which he split with his ex-wife after the sale. I'm not saying that a 2008/9 event will happen again but a major correction is likely during the remaining duration of a mortgage.

 

[COcheesehead]

My frustration has always been at the people who claim that paying off the mortgage was so very important, a no-brainer,

-ERD50

Cough... I said "to me, it's a no brainer". A little different meaning than your quote.