Pay off mortgage or put money into bond fund?

[cardude]

I've been agonizing for months over getting the bond side of my AA set up in this uncertain environment. I'm worried that bond funds NAVs are due to fall as rates gradually increase sometime in the future. So, a huge part of my portfolio (35%) currently sits in cash earning about 1.75% pre tax.

Why don't I just pay off my mortgage instead of worrying about investing the money into bond funds right now? I didn't really wannt to do that because I wanted to take advantage of paying my mortgage down with inflated dollars eventually. Plus, I really didn't want to tie that much money up in an illiquid asset (would take about 12% of my portfolio if I paid it off), but when I plug the numbers into my SWR spreadsheet my SWR rate drops from 2.8% to 2.23% if I pay it off.

Long term am I better off with a guaranteed 5.12 after tax return by paying off the house or should I just hold onto the cash and wait for the bond market to "correct"? What am I missing here?

My mortgage is 5.12%, I'm in the 25% federal tax bracket this year, and I'm retired but DW is working for the next couple of years. We plan on staying in this house for about 10 years until the kids get out of school.

 

[Kronk]

my SWR rate drops from 2.8% to 2.23% if I pay it off.

I would suggest doing whatever will give you less stress. In either case, you are in great shape, and don't need to be "agonizing".

 

[Lusitan]

In your situation, since you plan to be in the house for at least another 10 years, I'd go ahead and pay down the mortgage. Actually, what I'd probably do is a bit of both, or a bit of all three -- invest some in bonds, keep some in cash, and pay down the mortgage with some. I tend to hedge my bets when it comes to questions like this.

As Kronk said though, this is a good issue to be "agonizing" over -- no matter what you do, you're in pretty good shape.

 

[cardude]

..........and don't need to be "agonizing".

Well, the part I was agonizing over was the bond fund purchase. Along with everyone else my cash is earning next to nothing, but bond funds look a little scary to me as well, so this "pay off the mortgage" was just another idea that popped into my head.

Maybe a better question would have been, "Do current low cash and bond yields alter the age-old pay off your mortgage or keep it conundrum?"

 

[LOL!]

If you have losses in your kids' 529 plans, you should cash them in and pay off the mortgage. You'd get a great tax deduction on the 529 losses, so this makes sense.

 

[ERD50]

Maybe a better question would have been, "Do current low cash and bond yields alter the age-old pay off your mortgage or keep it conundrum?"

I'm not sure that you can ever count on cash and bonds to out-yield a mortgage over the long run.

In the FIRECALC runs I've done, keeping the mort had a slight advantage, and that was with maintaining my AA. And I think that is because you can have some reasonable expectation of stocks out-performing bonds (and a 5% mortgage) over the long run.

-ERD50

 

[rayvt]

Well, the part I was agonizing over was the bond fund purchase. Along with everyone else my cash is earning next to nothing, but bond funds look a little scary to me as well, so this "pay off the mortgage" was just another idea that popped into my head.

Maybe a better question would have been, "Do current low cash and bond yields alter the age-old pay off your mortgage or keep it conundrum?"

No. Today the yields are low, true. But in 5 years what will they be? 6%? 7%? If so, you won't be able to change your mind and get that money back out of your mortgage.

 

[Bikerdude]

CD. Do you need the mtg interest deduction to itemize taxes? I would think that with normal inflation and your tax deductions your real cost of money is very low. However, paying off the mtg is the safe way to go if you don't have to sell the house to eat in the future.

 

[haha]

I've been agonizing for months over getting the bond side of my AA set up in this uncertain environment. I'm worried that bond funds NAVs are due to fall as rates gradually increase sometime in the future. So, a huge part of my portfolio (35%) currently sits in cash earning about 1.75% pre tax.

Long term am I better off with a guaranteed 5.12 after tax return by paying off the house or should I just hold onto the cash and wait for the bond market to "correct"? What am I missing here?

i don't think you are missing anything. This is a good statement of the situation. BTW, I'd like to be earning 1.75% on liquid funds. Where are you getting that?

You are a clever, successful businessman. Surely for most of your life you would have grabbed a fixed interest, fixed term loan at the rate on your mortgage.

I'd keep the mortgage, keep the liquid cash. My motto is allocation, smalocation. ( Admittedly a minority postion.) At todays rates, when it comes to longer term funds I want to be a borrower, not a lender.

Ha

 

[cardude]

BTW, I'd like to be earning 1.75% on liquid funds

Ally Bank; the old GMAC bank. Very easy to set up and direct deposit..

I've got some cash at various other online banks (Capital One, FNBO) but they have recently dropped their rates to 1.6 and 1.5%, and their transfers are much slower.

 

[nun]

I never agonize about what bond funds to buy, I just dollar cost average into Vanguard Total Bond Market Index. I'd divide your cash into 4 pots, one to buy equities, one for bonds, one to leave as cash and one to pay down the mortgage. During the recent market run up I've been cashing in 50% of my gains and paying down the principal on my mortgage. I've decided to take some profits on the way up rather than letting it all ride until we get to another crash.

 

[2good]

... BTW, I'd like to be earning 1.75% on liquid funds. Where are you getting that?...
Ha

Discover Bank is paying 2% on their online savings account.

 

[W2R]

Long term am I better off with a guaranteed 5.12 after tax return by paying off the house or should I just hold onto the cash and wait for the bond market to "correct"?

Read all the posts, think, analyze, consider.... and then pay off your mortgage! OK, as you probably realize the eternal debate over paying off a mortgage or not is not likely to be solved in this thread. If you are the type of person who can put that mortgage payment directly into your nestegg instead of spending it, and if you think that mortgage companies know how to invest too and are not in the business of losing money, then I think you will be pleased just as your spreadsheet indicates.

If one is ready to sell a paid-off house and buy another that is less expensive, then the proceeds from the paid-off house can pay for the next one. So, essentially you have bought THAT house in cash, too. In fact it is possible that you will never have to pay on a mortgage again, for the rest of your life.

So think about it and make your own decision. If never having to send in a mortgage payment again in your life is more appealing to you than putting that money into a bond fund in these uncertain times, then you know your answer.

 

[Bestwifeever]

That's a pretty big drop in SWR imho. And you are a young man (you're welcome ) and want your nest egg to last. And getting rid of those mortgage payments will make your spouse's income look larger. Personally, I'd pay that mortgage off even though on paper it might make sense to keep it. An individual decision.

 

[rayvt]

When I FIRE'd at age 58, numerous co-workers came into my office to ask how I did it. Many of them had had 15 year mortgages which were now paid off. They were uniformly surprised when I told them I still had my 30 yr mortgage.

When I asked them if they had taken their previous mortgage and put it all into investments, they generally said, "Yes. Some of it, not all of it. Maybe about half. Almost."

Not to say that this would happen to you---or anybody else here. But from my sample it looks like a lot of people get the house paid off and then spend the former mortgage payments instead of saving/investing it.

 

[ziggy29]

Not to say that this would happen to you---or anybody else here. But from my sample it looks like a lot of people get the house paid off and then spend the former mortgage payments instead of saving/investing it.

This is an important point. A paid-off home only builds wealth if you save and/or invest the cash flow which used to go to paying the mortgage. If someone thinks they'd start blowing a lot of the extra cash flow on consumable and depreciating "stuff," from a wealth building standpoint they are better off keeping the mortgage.

 

[tryan]

Cardude, you've taken all the risk you needed to take to get where you are ... no need to take any more. Pay the mortgage off and enjoy life.

 

[cardude]

When I FIRE'd at age 58, numerous co-workers came into my office to ask how I did it. Many of them had had 15 year mortgages which were now paid off. They were uniformly surprised when I told them I still had my 30 yr mortgage.

When I asked them if they had taken their previous mortgage and put it all into investments, they generally said, "Yes. Some of it, not all of it. Maybe about half. Almost."

Not to say that this would happen to you---or anybody else here. But from my sample it looks like a lot of people get the house paid off and then spend the former mortgage payments instead of saving/investing it.

The mortgage payment just comes out of our cash pile right now, much of which is destined for our bond allocation whenever I get brave enough to pull the trigger. So, it's not like I'm going to take that money and start to blow it on crap-- we are on a strict budget and we follow it very closely.

Actually, by paying off the mortgage I would be reducing the amount of money that I have available to put into our bond allocation, which would put me at 37.5% bonds 51% stocks instead of the 45/45/5 cash/5 "other stuff" I was planning on.

I didn't think about how paying off the mortgage would alter my AA and skew it higher towards equities. Does this mean I would have to immediately rebalance? Hmmm...................

 

[Stevewc]

Hello Cardude,
I'm pretty sure you are reading everything on this forum but wanted to point out this article just in case. Top Stocks Blog - MSN Money

I found this very interesting and have been watching the Fed's manipulation for some time and its probable effect on bond funds.
So far I'm bating zero but still watching and trying to learn,
Steve

 

[Meadbh]

If you have a variable rate mortgage and interest rates rise, how would that make you feel? Personally (and this is a very personal decision) I would make hay while the sun shines, and pay down the mortgage. Done, over, move on.

 

[Tesaje]

Who is sorry he/she paid off the mortgage?

I'm not.

 

[Meadbh]

Who is sorry he/she paid off the mortgage?

I'm not.

NM

 

[haha]

If you have a variable rate mortgage and interest rates rise, how would that make you feel? Personally (and this is a very personal decision) I would make hay while the sun shines, and pay down the mortgage. Done, over, move on.

What makes a US mortgage so nice is fixed term, and fixed interest rate with no prepayment penalty.

If you mortgage does not have these characteristics, refinance.

Ha

 

[molly]

I do have a very definite opinion on this. You are still saving "some" for retirement whether or not your mortgage is paid. Having a paid for roof over your head is MARVELOUS.

My husband was "retired" a bit earlier than we planned. However, we live comfortably on his pension without having to take early SS or touch our investments in any way. This is possible because our overhead expenses are very low. We wondered how this was all going to work out and I can tell you that having a paid off house is a blessing and makes for good sleeping.

I know what all the tax experts say --- but beyond a certain point, if you run the numbers, you reallly aren't saving that much ala the IRS.

We had our house paid off in our early 50's and have been debt free ever since. It allowed us to save a lot more money towards retirement, and also .....made our kids college expenses not nearly as challenging.

Eventually, we will move and the $$$ from our house will be used to assist in our new purchase. If we need more $$$, we have been able to save that much more extra over the years because we didn't have the mortgage payment.

When the market is flat on its back, or in the sewer, it is wonderful to be debt free and just "let it ride".

 

[dizzy]

Why don't I just pay off my mortgage instead of worrying about investing the money into bond funds right now? I didn't really wannt to do that because I wanted to take advantage of paying my mortgage down with inflated dollars eventually. Plus, I really didn't want to tie that much money up in an illiquid asset (would take about 12% of my portfolio if I paid it off), but when I plug the numbers into my SWR spreadsheet my SWR rate drops from 2.8% to 2.23% if I pay it off.

Is your mortgage payment fixed? If so, be sure to model it as a non-inflation adjusted expense. This usually makes the payoff picture a little closer call in terms of SWR, since your expenses will decline in real terms. e.g. if your yearly mortgage expense is 20k, in 30 years of 3% inflation that will equivalent to an 8k expense today.

You can model this in firecalc by using a non-inflation adjusted expense to represent your mortgage, offset by a non-inflation adjusted pension of the same amount starting the year your mortgage is paid off.

Or, looking at it another way, the conventional portfolio survivability SWR targets (4%, 3%, whatever) typically assume all expenses grow inflation adjusted. For a scenario where some expenses do not increase with inflation, initial SWR can actually be higher at the same level of survivability risk.