Pay off mortgage early ?

[renferme]

When my mortgage gets down to what my stocks + cds are worth, in about 3 years, should I payoff the mortgage ? If I do payoff, I would have my pension and 401k remaining. Or I could wait 4.5 years, when I'm eligible for Soc. Sec., make the payoff, and have pension, soc. sec, 401k, and a little left in stocks/cds.
What do you think ?

[sgeeeee]

I will offer my view on this subject, although I predict that it will be criticized ruthlessly by almost every other poster on this board. Most FIRE types become almost obsessive about the importance of paying of your mortgage before you retire. And if you feel that way, you should do it.

But before you do, you should look at the numbers and see if that move is really consistent with your risk/reward character. If you have a 30 year loan in the 5% to 5.5% range, the odds are good (on the order of 70% - 85%) that you will be better off financially by paying the regular loan payments to the end, and investing the payoff amount for the remainder of the loan period. Choosing to do this also 1) increases your odds of beating a period of high inflation and 2) increases your expected terminal portfolio value. This latter advantage means that you will have greater odds of being able to increase your safe withdrawal rate at some point during your retirement.

There is some risk (~ of 15% to 30%) that this strategy will not result in finanacial advantage and that you will pay more over the life of the loan than you will make from your investments. You can analyze the magnitude of the risks and rewards using FIRECALC. Use the Loan amount as the nest egg value, the length of the loan as the time in retirement, the annual payments as the withdrawal rate and check the box for no inflation. The resulting probability of success is the probability that investing the money will put you ahead of paying off the mortgage. To evaluate the magnitude of the risk, decrement the withdrawal amount till you achieve 100% probability of success. The difference between your actual payments and this number represents the amount of money you are risking under worst case assumptions.

In reality, if you choose to keep making payments, the upside is slightly better than what FIRECALC will tell you since that analysis will ignore the tax advantage that goes with making mortgage interest payments. (That is probably a small amount). You also have the opportunity to reduce your worst case risk at any time during the loan by paying off the balance and thus reducing your investment loss impact.

[unclemick]

Agree - first run the numbers - and then add in the emotional/mental considerations.

[cute fuzzy bunny]

Well, there are several factors:

- Can you make more money off the investments than you are paying in mortgage interest. If you're early in the mortgage, the front loaded interest is heavy. If you're late in the mortgage, the % of remaining payments set to interest may be quite low. I paid off two mortgages recently that were past their half-way point, and the interest savings as a % of my payoff were not really terrific.

- If you're early in the mortgage, at a rate over 5.5% and ARE paying 2/3-3/4+ of the payment as interest, you might reduce your fixed income assets as part of your investments and pay off the loan, considering it sort of paying yourself a bond at the mortgages interest rate. This is how I looked at it: the money I saved was approximately 4.25% by making the early payoffs. Its hard to get a 4.25% yield with absolutely guaranteed safety and zero risk these days and likely for a while longer. So I made the payoffs and cut my bond and cash instrument holdings.

- The signficant psychological benefit to not having a six figure rock hanging over your head is not to be dismissed as minor. Plus you do not need to worry about making the mortgage payment, AND your worry about withdrawl rates from investments is lower because you can remove the biggest nut from your monthly payments.

THAT having been said, I wouldnt do this unless you had significant assets to bring to bear. If as you say this will wipe out your taxable investment portfolio and leave you with just non-taxable retirement assets, unless you are very early in a high interest rate mortgage I wouldnt consider it. And my move in that case would be to get into a lower interest rate mortgage, probably a 7 year fixed and then variable...those have some pretty sweet rates right now and by most statistics you either wont still be in the same house in 7 years or you'll be in a better position to pay off the note or refinance it if rates are still (or have returned to) at good levels.

[cute fuzzy bunny]

Hah, three answers at the same time...

Where else can you get such service

[wzd]

The other variable: Do you plan to move?

My case is that we are in a large house for 5 to 10 more years till kids are thru college and on their own. Then we will sell, and buy a smaller house with the equity. No more mortgage at that time. But I will not liquidate my investments that provide cash to live on in order to pay the large house mortgage down.

Wayne

[Bob_Smith]

I avoided this decision altogether. About 15 years ago we refinanced our house with a local bank. We agreed to set-up a savings account there, and to keep enough money in the account to cover the monthly mortgage payments. The bank automatically swept the payment each month - it was for their convenience. The interest rate on the savings account was dismal, but I only kept enough there to cover the payment, so it was no big deal. About three years into that arrangement the bank decided to add an annual fee to all their savings accounts, which weren't competitive to begin with. I wrote to the bank and said I wouldn't pay the fee because it wasn't part of our original agreement; I pointed out that I was holding the account for their convenience, so they could either waive the fee or I'd close the account and make the payments by mail, whatever they preferred. A bank officer called and spoke with my wife. She was very condescending and snotty and said they might waive the fee, but if they did, we'd never be able to borrow from them again. She had seen our modest home, knew we weren't big earners, and probably thought we didn't have two nickels and would be dependent on them forever.

Fortunately we had already started saving, but we hadn't been at it for long. We scraped together every dime we had and sent a check to the president of the bank. We paid off the mortgage entirely and told him why. The next day that snotty bank officer was on the phone pleading with me to reconsider. That was a call I'll never forget. It still gives me a warm feeling.

This doesn't address your question, bennevis. Just know that whatever you decide to do is bound to be smarter and more rational than paying off a mortgage for spite. We may have lost money when it was all said and done, but it was worth it.

[unclemick]

During the Savings and Loan Crisis era I was within 2-3 years of paying off our duplex - fearing the worst I tryed to pay off the morgage - went thru seven(yes 7) companies(with the help of a lawyer at my own expense) before one stayed solvent long enough to acknowedge payment and allow me to get a clear title. At one time I had as many as three payment books all wanting money for the same morgage at higher payments than the original contract.

Yet another reason I love stocks. That's one I blotted from memory until the 'warm feeling' mentioned - your warm was better than my 'warm feeling' - more like hot.

In my case, the psychological benefits of having no
mortgage are quite large. This includes having all
of that money "off the table" so to speak. I have learned that it is good for me to make it at least
inconvenient to access my money. The same theory
plays into my very long term bond portfolio. Of course,
you can overdo this type of thinking. In my case though, it helps to protect me from myself.
I was once accustomed to "livin' large". From time to time I tend to "backslide".

John Galt

As far as myself paying off the mortgage. I did last August - 2003.

Here was my thinking. Went though my Investment Plan and figured I needed to be in 60% stocks and 40% fixed income (fixed not for any growth - just to lower volatility). So I'm asking myself - where do I park the 40% to get the best return I can.

Viola !! - I know where I can Park $180K and get a guarenteed 5 1/4 % for 9 years! So I did it. I paid it off! Then there is the intangible benefit of not being in debt for anything! - I don't regret it yet!

I am going to park the rest in a Vanguard Short Term Bond Fund and hope than I can get 5% over the next few years!

[wabmester]

Quote:

When my mortgage gets down to what my stocks + cds are worth, in about 3 years, *should I payoff the mortgage ?

Revisit the question in three years. At that time, if interest rates are higher than your mortgage rate, then keep the mortgage and invest at the higher rate of return. Otherwise, pay it off.

[wzd]

Quote:

Revisit the question in three years. At that time, if interest rates are higher than your mortgage rate, then keep the mortgage and invest at the higher rate of return. Otherwise, pay it off.

Actually not a bad strategy for anyone in this interest rate market. A 30 yr fixed mortgage is one of the few investments that both fix the interest rate for 30 years and allow prepayment (callable) by the borrower. So this could be considered a very poor time to pay off a mortgage, since keeping a 5 to 6% mortgage while rates soar would end up being a very good deal. There is very limited downside; just pay it off if rates stay the same.

Wayne

[sgeeeee]

As I mentioned in my earlier post, you have to run the numbers for your specific case. I just went back and looked at where I'm at after choosing to take on a mortgage. Back in November 2001 I moved to my chosen retirement city and purchased what I intend to be my retirement home. I had to decide whether to buy the house outright or get a mortgage. I chose to take out a loan for 80% of the home ($150K mortgage) at 5%. Based on the performance of my 55% equity/45% fixed income portfolio since that time, I could now pay off the loan with the earnings from the original purchase amount and still be more than $30,000 ahead.

That translates into approximately $100 a month higher withdrawal rate that I can take for life -- after only 2.25 years. If you believe what folks like Warren Buffet say regarding expected returns over the next 10 years (~7% - 8%), I might expect to gain even more than this over choosing the payoff route through the next decade.

A lot of people get very emotional about the need to pay off their mortgage in retirement, but if you look at the numbers, you may be passing up one of the highest probability bets you can make with your money by paying off a low interest mortgage early.

And as pointed out in previous posts, it's a bet you can always choose to cancel unilaterally by calling the loan. But once you pay it off, you can no longer choose to make the bet.

[earlyout]

I think valid cases can be made for either side of this question. However, I tend to go for the mortage payoff. In part, because it is a timing issue, if the market is good (uptrend) over a period of years then chances are that this will be a benefit to have your house equity in the market. If there is a bear market, then your home equity is going down with the market. From 2000 to 2003, which option would have been better? You would have had a 30-40% drop in your investments and your mortgage payment would still be due each month. If you had paid off mortgage, you would have had a 5-6% return (your mortgage interest rate), plus no mortgage payments. Yes your investments still went down, but you had greater cash flow (because reduced expenses) plus no worry about when the market would turn around as you watched your house equity evaporate in the market. In hindsight it is easy to say well the market turned around in 2003 so it is OK. However, the mental and emotional pain of seeing your $200,000 house equity evaporate and still have to make house payments is something to think about. In short, you can "take" more volatility if you know the roof over your head is not going anywhere. Another way to view this issue, is would you take out a equity loan on your house to invest in the market? It is a gamble that may payoff, if it doesn't it is a high price to pay.

I look at it a bit differently. If you have a low interest rate mortgage, by not paying it off you retain the option of investing in the market over the long haul (not just a few select years), and you keep the cash for emergency medical or other needs. You still have the flexibility to pay off the mortgage at the time of your choosing, while paying it off now may give you less flexibility (i.e.; home equity loan at high rates). It comes down to whether you can make more than 5%-6% in the market over the long haul, which has historically been the case. Your capital gains on the house will materialize whether or not the house is paid off. Good luck!

[Ted]

This discussion brings up a lot of valid points both for and against paying off a mortgage. *As usual, my approach has been middle of the road.

We owned our house outright, but mortgage rates became so low that I couldn't resist doing a little interest rate arbitrage. *We expect to sell our house within 3 years, so we took out a "hybrid" mortgage on about half of the value of the house. *We get a very attractive fixed rate (around 4%) for 3 years, and then the rate can be adjusted upwards by an amount that is capped. *(That is irrelevant if we sell the house before then.)

We took this money and invested it in several relatively "conservative" high yield bond funds, yielding around 8% (and having the prospect of some capital gains, which have in fact occurred).

If anyone is interested in this type of mortgage, they can get it online through:

http://www.amerisave.com/

I should qualify this by pointing out that it does involve the risk that the invested money may lose value. In our case, my wife is still working at a good job and we can afford this risk.

[renferme]

thanks to all for responding. My gut feeling right now is to pay it off in 3 to 4.5 years. 4.5 years because that's when I qualify for soc. sec. The soc. sec. would make up for the lost income resulting from paying off the mortgage. Also, saving about $800 per month from not having the mortgage payment seems real good to me. At that time, I would be 62 years old, have my pension, soc. sec. and 401k to live on. Also, my young wife still works, which is nice. Will revisit in about 3 years to analyze again.

Ben

[sgeeeee]

bennevis, sounds like you pretty much have made up your mind and are comfortable with the decision. I think that's the important thing. I did want to clear up a few misconceptions that showed up in another one of the posts before I drop this. Again, I'm not trying to convince people to do it my way, but I really remain astonished that so many people seem to make this decision based on emotion rather than an analysis of the odds.

Quote:

. . . I tend to go for the mortage payoff. In part, because it is a timing issue, if the market is good (uptrend) over a period of years then chances are that this will be a benefit to have your house equity in the market. If there is a bear market, then your home equity is going down with the market.

Actually, paying off the mortgage is more of a timing issue. If you pay off a 30 year mortgage early, you are betting that you will not be able to beat the interest of the mortgage over the remaining years on the loan. Keeping the mortgage is more of a 30 year buy and hold decision based on the long term data.

Quote:

. From 2000 to 2003, which option would have been better? You would have had a 30-40% drop in your investments and your mortgage payment would still be due each month. If you had paid off mortgage, you would have had a 5-6% return (your mortgage interest rate), plus no mortgage payments.

But this is a short term way to look at the problem. The analysis needs to be done for the duration of the loan -- if you take a long term view of things. In my first post in this thread, I explained how to do the long term probability analysis rather than look at just a few years. As I pointed out, the results for a 30 year duration loan will give you a fairly high (~75% to 85%) probability of coming out ahead over the long run. Of course, we all understand that over the short run anything can happen.

Quote:

. In hindsight it is easy to say well the market turned around in 2003 so it is OK. However, the mental and emotional pain of seeing your $200,000 house equity evaporate and still have to make house payments is something to think about.

And certainly the emotional issue is very personnal. Many people do not feel comfortable with a long term buy and hold strategy during short term dips. As I pointed out in my first post, you can evaluate the worst case historical scenario for your personal situation in order to gain an understanding of how much the worst economic times in our history would have cost you using this strategy.

Quote:

. In short, you can "take" more volatility if you know the roof over your head is not going anywhere. Another way to view this issue, is would you take out a equity loan on your house to invest in the market? It is a gamble that may payoff, if it doesn't it is a high price to pay.

This is very emotional language, but I don't think the reasoning is very sound. If you are paying off your mortgage, and the market doesn't beat your mortgage interest over 30 years, then you end up making less money over the 30 years of payment than you would have made had you paid it off. Odds are against that happening, but there is a chance that you end up down by a small amount.

But if you could have paid off the loan before retirement, then you must have had at least that much money as surplus over the money you were going to use to retire. In order to lose your house, you must assume that you have lost most of your retirement nest egg and most of the payoff money that you started with, within the duration of the loan. Now . . . that may be possible, but if it does happen, I would suggest that you have greater problems. In fact, if you are in that much trouble that early in your retirement, I'm not sure owning your house is really more important than buying food and clothing. With money, I can alway rent a roof. But I can't buy food with a roof. Starving to death with a roof that you own is not very appealing.

Again, if you just have an overwhelming emotional draw to owning the house outright, then that's what you should do, but I do think people would serve themselves well to actually run the numbers for their situation before they make that committment.

[wabmester]

I remember somebody describing a mortgage as going short on a 30-year bond with a free put option. If interest rates rise, you win. If interest rates fall, exercise your free put and your loss is limited to the interest you paid while holding the short position.

I can't think of a safer bet. I wish the stock market worked that way

[renferme]

Thanks guys, I think I understand the logic as to why it may be better to postpone the payoff, but the psychological side of me, right now anyway, is saying I'll feel so much better if completely and totally out of debt. But will run the numbers in about 3 or 4 years from now and see how I feel then.