Pre-paying Mortgage Perspective after the "Crash"

[stephenandrew]

Apologies if this has already been asked/addressed, but given the big drop off in the market, are there any folks out there who are re-evaluating the wisdom of not prepaying thier mortgage and investing the difference in equity mutual funds? I know lots of folks have always felt that given the deductibility of mortgage interest, and the typical longer term higher returns available in equities, that keeping the mortgage was the best financial decision. I have not run the numbers, but I am wondering if prepaying has been a better decision than investing in the market given the recent financial environment. On a personal note, I have been prepaying my mortgage (throwing about an extra $1000/month at a 15-year fixed rate mortgage [5.25%]), and for me, on the surface, it seems like the only good financial decision I have made these days. Atleast I will have a paid off house where I can look at my sad mutual fund statements.

Thanks.

 

[Architect]

I've always thought prepaying was a good idea, and that the idea of not prepaying and investing the difference in stocks was a fad that would pass during the next bad bear market. Anecdotally it seems to be the case.

People are again realizing that a smaller guaranteed return often beats a possible larger return, I think.

 

[hankster]

I feel it's an individual's choice depending on what one is comfortable with. For me personally? I'll take the paid off home. Someone else can carry a mortgage and try to get a spread with their investing.

 

[ziggy29]

There are two schools of thought on this "payoff mortgage or invest" question: one is that stocks are pretty "cheap" now and thus represent a better buy than usual. The other is that prepaying a 5.5% mortgage is effectively a sure-thing, 100% safe 5.5% return on your money, and there's basically nowhere else you can get a sure thing return that high than to pay down the mortgage with excess cash flow.

Personally, if I were in the position of deciding between accelerating mortgage paydown and investing more, I'd probably hedge my bets and do a little of both, since I see merits in both of those arguments. Having said that, being fortunate enough to have a paid-off house I know how much peace of mind that provides in times like these, and you can't easily put a specific dollar amount on that feeling.

 

[CybrMike]

I am so happy that I didn't pay off my mortgage right now. I like having the extra few hundred K around as a cushion when times get tough.

 

[Lusitan]

I have never been able to decide which is better, so I have pretty much split the difference: after I max out all of my tax-favored retirement plans, the rest of my savings is split between investments (per my asset allocation) and paying down the mortgage and student loan debt I have.

I figure I will only be half-wrong no matter what the right answer turns out to be in retrospect.

 

[Nords]

Apologies if this has already been asked/addressed, but given the big drop off in the market, are there any folks out there who are re-evaluating the wisdom of not prepaying thier mortgage and investing the difference in equity [-]mutual[/-] exchange-traded funds?

No.

And as Charlie Munger says, "I have nothing further to add."

 

[stephenandrew]

I am so happy that I didn't pay off my mortgage right now. I like having the extra few hundred K around as a cushion when times get tough.

So that is an interesting point---you are less concerned about the return than preserving liquidity. I gather that you did not put the money you could have used to pay off the mortgages into equities then, but rather something more stable? MMF? If it had been in equities, I assume your "few hundred K" might previosuly have been 600 or 700K.

 

[ERD50]

.... and the typical longer term higher returns available in equities,


Thanks.

Since this subject *has* been beat to death time and time again, I'll only add that the bolded words above are the key.

It makes no more sense to evaluate a long term decision right at the point when stocks are down, than it does to evaluate that long term decision right at the point when stocks are way up. With that thinking, at any point in time there are 'good' and 'bad' investments. But you can't make rational long term decisions on what an investment did just recently.

Now, if any 'mortgage arbitrage' players out there were bragging about their decision when stocks were up, they deserve some ribbing now that they are down. But I'm pretty sure that most of them were not tooting their horn, they realized that it was a long term plan that would have ups and downs - one that may or may not work out.

-ERD50

 

[ziggy29]

By the way -- the musings I posted earlier assume an adequately funded emergency fund. So even though I'd probably divide excess cash flow between paying down mortgage debt and investing *if I had a fully funded emergency stash of cash*, if my emergency fund were deficient I'd use the first few months of extra cash flow to boost that until I had at least six months of expenses in it -- preferably a year in this economic environment where new jobs are much harder to come by.

 

[stephenandrew]

Now, if any 'mortgage arbitrage' players out there were bragging about their decision when stocks were up, they deserve some ribbing now that they are down. But I'm pretty sure that most of them were not tooting their horn, they realized that it was a long term plan that would have ups and downs - one that may or may not work out.

-ERD50

I would gently disagree---some, not all, but some of the folks who promoted the idea of "investing the difference" were nearly fanatical in their belief that for anyone to pay off their mortgage early was foolish, and their intelligence was in question. I would also suggest that this has been a pretty significant set back in terms of equity values (a big "down"), and as such, it might have made some people second guess their decision--I know I do that all the time.

 

[ERD50]

I would gently disagree---some, not all, but some of the folks who promoted the idea of "investing the difference" were nearly fanatical in their belief that for anyone to pay off their mortgage early was foolish, and their intelligence was in question.

You might be right - maybe my memory is filtered by my own bias. But I really don't recall those posts, or maybe I skipped over them for the drivel that they would represent (pre-filtered, if you will ).

BTW, so you understand my 'bias' comment - my personal feeling is that paying off or not paying off is probably one of the least significant decisions that a person has to make. I don't think it's going to make a big difference either way. But that is why I cringe when people get all excited and are throwing confetti around, celebrating the fact that they used their savings to pay off their mortgage. I can understand celebrating that you managed to save enough to pay it off, but whether you do or not seems relatively unimportant. It might be to your advantage or it might not, and you won't know until it's too late to change. whooopee.

-ERD50

 

[Gardnr]

I would gently disagree---some, not all, but some of the folks who promoted the idea of "investing the difference" were nearly fanatical in their belief that for anyone to pay off their mortgage early was foolish, and their intelligence was in question.

On this forum, or somewhere else? Most of those on this forum have recognized the trade offs, risks, etc. and the fact that it is a complicated decision that depends a lot on personal circumstances. In other words a balanced, reasonable discussion. But maybe I just [-]ignored[/-] discounted the others.

Elsewhere I have seen the kind of single-minded fanatical perspective that you refer to.

 

[ziggy29]

On this forum, or somewhere else? Most of those on this forum have recognized the trade offs, risks, etc. and the fact that it is a complicated decision that depends a lot on personal circumstances. In other words a balanced, reasonable discussion. But maybe I just [-]ignored[/-] discounted the others.

Elsewhere I have seen the kind of single-minded fanatical perspective that you refer to.

I don't see as much of it here, but occasionally I do.

"Pay off debt or invest" is right up there with "rent or buy" in terms of financial discussions that get people riled up as if there's always a one-size-fits-all answer, which is almost never the case.

 

[rayvt]

ERD50 made the key point. To invest in the market for short-term considerations is foolish. The proper viewpoint is to look at long-term, not short-term results.

The recent market crash is a short-term issue. Both a house mortage and a retirement investment portfolio are long-term issues.

In truth, if you had a large stockmarket account a year ago, the BEST thing to do would have been to go to cash and put that in CDs, not to cash out and pay the mortgage.

But nobody is prescient, which is why you have to go by the numbers. 10.5% (average) is more than 5.75% (fixed).

 

[ziggy29]

But nobody is prescient, which is why you have to go by the numbers. 10.5% (average) is more than 5.75% (fixed).

Agreed. But that's why it depends on your goals and your risk tolerance.

Some people are risk-averse enough that they'd rather have a sure-thing 5.75% than a risky 10.5%. That's a personal risk tolerance decision that everyone needs to answer for themselves.

You also have to be pretty sure you don't need the money for many years (I'd say 10+, maybe 15+) and that you're not going to panic and sell low when stocks are in the tank. Not everyone is in that boat.

 

[Texarkandy]

I think it depends on your personal situation.

If you are 30 years old with a good 4.5% 15 year fixed (like me) & planning to ER at 50, you might not be so concerned about having the mortgage paid off and a little more concerned with building your personal treasure.

If you are 48 years old planning to ER at 50 (like me) with a somewhat modest retirement plan, you might be a little more concerned about getting the remainder of that mortgage paid off, if only for cash-flow reasons.

 

[kowski]

My house is paid off and all my savings are invested in CD's and always has been. I might have not been the big talker at parties but I'm happy even in these down times.

 

[W2R]

Logically the decision whether or not to pre-pay one's mortgage should not be influenced by market timing because the effects of this decision have a long time horizon.

On the other hand, if one is disgusted with the market, why not? The emotional reassurance of having one's house paid off are immense, when the market is plunging.

Just don't forget to buy low, sell high, when it comes to equity purchases.

Personally, I paid off my home during the boom years of 2003-2006 and even so, I do not regret it.

 

[Frugality_of_Apathy]

Purely depends on your interest rate. Something in the 4% range probably isn't too important to pay off right away, but if you're in the 7% range that's definitely going to hinder you later in life.

The thing about the "guaranteed return" is more a question of having debt in general or not. If you never pay off your mortgage than you are always going to a a negative x% to compete with for all your investments. Getting an 8% return on your investment rather than paying down the 5% mortgage only leaves you keeping pace with inflation. Once that house is paid off all of your investments gains are actually gains and don't have to be siphoned off to pay for your debt every month.

What I do is rather than invest in stable funds I take that portion and pay down my mortgage and everything that goes into the market is set for maximum risk.

The question to ask your self is: Say you've got $20,000 in the market and a $100,000 house. Would you recommend to your friend with $80,000 debt on their house and no money in the market to refinance their house for $100,000 so they can put $20,000 in the market?
And if you would recommend that, ask yourself why you haven't refinanced your house to 80% of it's value this year to invest more.

 

[ziggy29]

The question to ask your self is: Say you've got $20,000 in the market and a $100,000 house. Would you recommend to your friend with $80,000 debt on their house and no money in the market to refinance their house for $100,000 so they can put $20,000 in the market?
And if you would recommend that, ask yourself why you haven't refinanced your house to 80% of it's value this year to invest more.

This is similar to what Dave Ramsey tells callers when they have thought about investing a windfall instead of paying off the mortgage with it. "If you owned your home free and clear, would you mortgage it in order to invest?"

Almost always, the answer is "no."

But in some sense, you are faced with the same decision: do I want a paid off home *or* a mortgage and some investments? But it's interesting how the psyche changes depending on which "direction" you ask the question in.

 

[bubba]

We are rethinking our plans a little. While we might not pay off the mortgage (12 more years @ 5%), we will likely try to have MMF or CDs in the amount to pay it off should we choose. In other words, we aren't comfortable with the fact that to pay our mortgage off right now, we'd have to liquidate equities in this market. This is more an asset allocation problem and we'll work on correcting that going forward. However, being totally debt free is really important to me, so I'm very sure that before we retire (looking like 8 more years now), we'll pay it in full.

 

[ziggy29]

We are rethinking our plans a little. While we might not pay off the mortgage (12 more years @ 5%), we will likely try to have MMF or CDs in the amount to pay it off should we choose. In other words, we aren't comfortable with the fact that to pay our mortgage off right now, we'd have to liquidate equities in this market.

To be honest, in *this* economy, I wouldn't be inclined to pay off a 5-6% mortgage anyway. I'd rather have cash in the bank.

There's never a more important time to maximize your liquidity than when the economy stinks. Unless you are securely retired or have a ridiculously secure job, it's hard to have too much cash right now.

But when the economy improved to the point where I was no longer worried about prolonged unemployment, then I'd be inclined to do something more productive with the cash (such as pay down the mortgage or invest some of it, or maybe a little of both).

 

[Frugality_of_Apathy]

But in some sense, you are faced with the same decision: do I want a paid off home *or* a mortgage and some investments? But it's interesting how the psyche changes depending on which "direction" you ask the question in.

The point is money is a hard fact. You should be able to ask a question both ways and get the same answer. Risk is risk, you wouldn't go to a roulette table and try try to convince someone at a roulette table that betting on black is a much better investment than betting on red. The risk is the same no matter which side you place your bet on.

Just like with drawing, if you draw something you think looks good but then with everything in proportion and it's easily recognizable, and then flip it over and look at it from the backside with a light box or something, it may look horrible and full of flaws from the back. You can't say "Well it's only drawn to look good from this side," because by looking at it from the opposite side you've just revealed your bias and a legitimately good drawing will look good from both sides.

 

[ERD50]

Some people are risk-averse enough that they'd rather have a sure-thing 5.75% than a risky 10.5%. That's a personal risk tolerance decision that everyone needs to answer for themselves.

I agree, it is a personal decision - no right/wrong about it.

However - I seem to find an inconsistency among people who choose the 'sure thing' side. I think that many of them have no problem having some money invested in stocks while they are in the process of paying off their mortgage.

But, doesn't that 'sure thing' view really say that you should not have a single penny invested in stocks until the mortgage is eliminated? That every penny should go towards the mort first? Like some of the posts above, it seems they are looking at the same factors from different sides, and coming up with a different answer.

-ERD50