Why Pay off the mortgage?

[peorth]

I didn't have the time to read though the entire thread (and posted previous thread link) -- apologies if these points have already been brought up.

Why pay off, or not pay off your home?

On a 30-year loan, in year 1, about 90% of your payment is interest and 10% principal. So if you're young and in high tax bracket, you get lots of tax write deductions from the mortgage payment.

But as the years roll by, less $ is paid to interest and more to principal, reducing your tax advantage. So if you're looking for a tax deduction advantage, it's much less later on.

For most people, I'd suggest paying off their homes early via extra payment every year method (reduce 30 year loan to 22?). Most people aren't financially disciplined and it's better to have them pay off the roof over their heads than to play with the $.

But if you're savvy with investments and willing to take risks, flipping homes and condos during RE up-cycle can make you a lot of $$. During the previous RE cycle (1998-2005) I refinanced my home, took out some $$ and bought another condo for investment, then sold it 4 years later. The $ I made from that sale is more than enough to pay off my loan on my primary residence. But I also accepted some risks and the rental property had negative cash flow for 4 years.

 

[aenlighten]

Mortgage SWRs

I ran the RetireEarly millennium calculator to determine the SWR for a fixed annuity/mortgage. While most should have less than 30 years available on theirs, I included the longer terms for those willing to refinance and extend it out further. Naturally, the shorter the period and the less safety assumed, the higher the rate you could tolerate.

Years 10 20 30 40 50 60
100% Safe 8.92% 5.44% 4.68% 4.44% 4.32% 4.28%
90% Safe 11.99% 7.87% 6.66% 6.08% 5.75% 5.57%

 

[RetireeRobert]

How do you figure?

For example, if I pay off a $100,000 remaining on a mortgage, it cost me exactly $100,000. There certainly is a price to pay!

.......If you find a financial advantage to paying off the mortgage, go ahead - but I think you'll find it to be a fairly small advantage - not in the 'priceless' category at all.

-ERD50

You're missing the whole point. YOU are the one still bogged down in "pricing" things.

I said nothing about finding "financial advantage" in paying off the mortgage (or not). If you re-read what I said, it was one can add up the pluses and minuses financially (of paying or not paying off the mortgage). And one can compare those "financial scores", if one is of a mind to do such.

BUT, regardless of all that "financial" stuff, the real payoff of paying off the mortgage is the sense of freedom, the cachet of being "debt free". The value of that cachet, that feeling, has nothing to do with price---they are priceless.

A few later posters "got it". Read their replies too.

 

[audreyh1]

Looking back I realize why our paying off the mortgage was a wise decision.

> 90% of my net worth was in company stock. Of course I was dependent on the company as well!

By selling a small amount of company stock to pay off my mortgage, I took some risk off the table. If the company stock dropped something awful AND I lost my job, at least I didn't have to worry about those house payments. This made it easier to sleep at night plus the "house payment" was redirected to an investment account instead. Of course it's amazing that we could sleep at night anyway since we were making such big gamble on the company stock appreciating enough to let us ER.

Our interest payments dropping below the standard deduction was what got me to look at the situation in the first place.

A few of my coworkers thought we were nuts to trade company stock for mortgage since in their opinion, the company stock would appreciate much faster than the house. They turned out to be right! But they also didn't realize how MUCH company stock we owned - LOL!

One of my peers took the opposite approach. He took out margin loans against his company stock to build a house worth 10x the one we paid off! Talk about ratcheting up the risk!! He must have made out OK - unless he is still buying stuff on margin, LOL!

Audrey

 

[ERD50]

You're missing the whole point. YOU are the one still bogged down in "pricing" things.

I said nothing about finding "financial advantage" in paying off the mortgage (or not). If you re-read what I said, it was one can add up the pluses and minuses financially (of paying or not paying off the mortgage). And one can compare those "financial scores", if one is of a mind to do such.

BUT, regardless of all that "financial" stuff, the real payoff of paying off the mortgage is the sense of freedom, the cachet of being "debt free". The value of that cachet, that feeling, has nothing to do with price---they are priceless.

A few later posters "got it". Read their replies too.

OK, but maybe you are not understanding my posts.

I have no problem with someone saying they feel a 'sense of freedom' in being debt free, or whatever. That's fine.

But if that 'sense of freedom' does not have a sound financial basis, isn't it OK to question it?

Along similar lines, the great debate over annuities. Maybe someone 'feels better' about having a 'lifetime income'. OK, but what if that lifetime income is less than what they could obtain through other means? Is it really so great? Worth debating, I say.

It is my impression (and maybe I'm mistaken), that this great 'sense of freedom' comes from making a decision that takes them miles ahead financially. As far as I can see, paying off, or not paying off a mortgage is probably a small matter, financially.

As long as one recognizes that, fine - feel great about it, if you wish. But I'm still confused about what people feel so great about - it appears to be a minimal difference for most people, financially. So what is there to get excited about? What are all the congratulations about?

Analogy: One mutual fund appears to have a slightly better risk/reward ratio than another. So, you move $100,000 from mutual fund A, to mutual fund B. Fine, you think you made a wise decision. Great. But do you get excited and say "wow, I moved my money from one fund to another fund that may be marginally better, what a relief!"? Do people say, "wow, congratulations on moving your money from one account to another that may be marginally better - it feels great doesn't it - I am so envious"?

I fail to see how moving money from one account to a 'house
equity' account makes any big difference to anyone. Your net worth has not changed. Maybe you made a slight positive move financially, or maybe not.

Why does this make some people feel so good? I just do not 'get it'. Sorry.

-ERD50

 

[clifp]

...


The exceptions to this are people with a decent pension or job that eliminates the debt payment and its risks, or someone with the intent to invest nearly 100% in equities regardless of payment obligations. Someone that is working towards retirement but is still 5+ years away SHOULD have a favorably priced mortgage since they have cash flow.

Otherwise an early retiree takes on more budget risk, payment risk, income tax risk, investment risk, and has to load up on lower returning investments to smooth out the ride, in the hopes of eking out a percent or two of arbitrage from the higher returning investment components, should the markets comply.

I think there are other situations where paying off the mortgage doesn't make sense. Several people on the board including me have fixed mortgage below 5%. I just got a Pen FED CD for 6%. It seems me that if the you are comparing risk free investment, it doesn't make sense to pay off a 4.875% mortgage when I Pen FED will give me 6% for the money. On a 100K CD that is >$1000/year if in several years when it is time to reinvest CD rates have dropped to 3% then I pay off the mortgage but on the other hand if they have increased 7% I am doing even better.

Now, I agree with CFB if you are taking out $500K mortgage at 6% to invest the money in the market hoping to earn 8-9% on average the risk to reward is bad for an early retiree.

 

[ERD50]

Looking back I realize why our paying off the mortgage was a wise decision.

> 90% of my net worth was in company stock.

You have a diversification problem. There are many ways to resolve that. Only one of them is paying off the mortgage. There are/were many other options.

-ERD50

 

[ERD50]

I think there are other situations where paying off the mortgage doesn't make sense. Several people on the board including me have fixed mortgage below 5%. I just got a Pen FED CD for 6%. It seems me that if the you are comparing risk free investment, it doesn't make sense to pay off a 4.875% mortgage when I Pen FED will give me 6% for the money.

Agreed. But what I keep hearing from people is that it 'just feels so good to be debt free!'. 'Whoopee, lets throw a party!'. Regardless of the financial decision.

But sorry, I still don't understand what feels so good about (in the case clifp provides) losing 1% on your money.

Are people saying it is worth 1% to be able to say "I am debt free"?

1% takes you from a 4% SWR to a 5% SWR. Or, for $50K spend, from a $1.25M nest egg requirement, to a 1.00M nest egg requirement. $250,000. Don't sneeze at 1%.

-ERD50

 

[RetireeRobert]

OK, but maybe you are not understanding my posts.

I have no problem with someone saying they feel a 'sense of freedom' in being debt free, or whatever. That's fine............

...........I fail to see how moving money from one account to a 'house
equity' account makes any big difference to anyone. Your net worth has not changed. Maybe you made a slight positive move financially, or maybe not.

Why does this make some people feel so good? I just do not 'get it'. Sorry.

-ERD50

Maybe the problem understanding the "feel good" is in keeping thinking in terms of the financial pluses and minuses.

Why does it make people "feel good"? I'm not a psychologist, so for one answer I would say "it just does". It *is* a real feeling.

In another sense, I would say because then they are beholden to *no one*. They are "free". They are consequently more "in control" of their own fates. That makes them (and me) "feel good".

You say their net worth is the same with a mortgage and with the equivalent cash in the bank/invested, as is net worth with mortgage paid off and less cash. True. Very true.

But with a mortgage, they do "owe" someone. With mortgage paid off, yes their bank account/investments are also that much smaller, but then they owe *no one*.

You do admit that either way, it is either a "slight move financially. Or maybe not".

So do you not also then admit in essence, the "finances" of the decision are really irrelevent?

If so, make the decision on whether to pay off the mortgage or not based on "it makes you feel good" AND you are then beholden to *no one*.

Or as my first post said in this thread on whether to pay off the mortgage---"Why not?"

 

[Nords]

Agreed. But what I keep hearing from people is that it 'just feels so good to be debt free!'. 'Whoopee, lets throw a party!'. Regardless of the financial decision.
But sorry, I still don't understand what feels so good about (in the case clifp provides) losing 1% on your money.
Are people saying it is worth 1% to be able to say "I am debt free"?

You're trying to equate financial/quantitative decisions with emotional decisions.

A financial/quantitative decision would add up all the factors and compare them somehow to the emotional feeling of paying off the mortgage, and make a decision on that basis.

An emotional decision doesn't care about the financial/quantitative aspects of the issue.

You can argue about the financial/quantitative factors being ignored in an emotional decision, but it's irrelevant to the basis with which the person made the emotional decision.

You're trying to claim that the financial/quantitative basis for decision making is somehow better than the emotional basis for decision making. Your claim is only correct within the financial/quantitative perspective. To the person making the decision on an emotional basis, your perspective is irrelevant.

I'd recommend that you accept the existence of the phenomenon without trying to force it to fit within your view of the world!

 

[ERD50]

Maybe the problem understanding the "feel good" is in keeping thinking in terms of the financial pluses and minuses.

Why does it make people "feel good"? I'm not a psychologist, so for one answer I would say "it just does". It *is* a real feeling.

In another sense, I would say because then they are beholden to *no one*. They are "free". They are consequently more "in control" of their own fates. That makes them (and me) "feel good".

You say their net worth is the same with a mortgage and with the equivalent cash in the bank/invested, as is net worth with mortgage paid off and less cash. True. Very true.

But with a mortgage, they do "owe" someone. With mortgage paid off, yes their bank account/investments are also that much smaller, but then they owe *no one*.

You do admit that either way, it is either a "slight move financially. Or maybe not".

So do you not also then admit in essence, the "finances" of the decision are really irrelevent?

If so, make the decision on whether to pay off the mortgage or not based on "it makes you feel good" AND you are then beholden to *no one*.

Or as my first post said in this thread on whether to pay off the mortgage---"Why not?"

OK. So let's put a real live test to how good you feel.

Take clifp's example. Is it worth 1% (assuming all else is equal) to be 'debt free'? Recognizing that the cost of being debt free is to take money from some other account?

What about 2%, 3%, 4%.... ? ? ? ?

I'm just trying to understand how 'priceless' this feeling is. I'm guessing that there IS a price to it.

-ERD50

 

[Nords]

OK. So let's put a real live test to how good you feel.
Take clifp's example. Is it worth 1% (assuming all else is equal) to be 'debt free'? Recognizing that the cost of being debt free is to take money from some other account?
What about 2%, 3%, 4%.... ? ? ? ?
I'm just trying to understand how 'priceless' this feeling is. I'm guessing that there IS a price to it.
-ERD50

This type of logic is what makes Dilbert such a raging success with the hot chicks.

 

[ERD50]

An emotional decision doesn't care about the financial/quantitative aspects of the issue.


I'd recommend that you accept the existence of the phenomenon without trying to force it to fit within your view of the world!

Honestly, I'm OK with that.

If someone said 'I don't care about the finances - it just makes me feel better, so I'm doing it to feel better, come hell or high water', OK - there is nothing to discuss.

Heck, I have an irrational bias against eating bugs. Nothing anyone says is likely to change that, but I recognize that it is irrational. Bugs are good food.

But when people say it (paying off the mortgage - or not) as if there iS some big rational financial benefit, well I'm trying to understand that. Is there some stone I left un-turned that explains this feeling? Maybe I'm missing something.

If it is irrational, fine. I don't need to concern myself, I don't have an irrational fear of mortgage debt.

I'm just having trouble coping with all the 'congratulations' over a minor positive/negative financial decision. It's as if many people came up to me and said 'congratulations on your aversion to eating insects'. What's to congratulate? That I'm missing out on an efficient source of protein?

Color me confused and confounded - ERD50

 

[ERD50]

This type of logic is what makes Dilbert such a raging success with the hot chicks.

I'm so far past even thinking about what some 'hot chick' thinks of me, it not even funny

Unless I include my own personal DW as a 'hot chick' Which of course she is (to me).

-ERD50

 

[Nords]

Unless I include my own personal DW as a 'hot chick' Which of course she is (to me).

Good point, I wouldn't try Dilbert's logic on my spouse either...

 

[ERD50]

This type of logic is what makes Dilbert such a raging success with the hot chicks.

Sorry to be so obsessive about this, but it's not like the 'priceless' comment was directed towards how much we love our spouses, or our children - it was directed towards a financial transaction. And yes, we can put a price on those. They are what they are.

-ERD50

 

[Nords]

Sorry to be so obsessive about this, but it's not like the 'priceless' comment was directed towards how much we love our spouses, or our children - it was directed towards a financial transaction. And yes, we can put a price on those. They are what they are.

Hey, you're preachin' to the choir.

I'm just suggesting that there are two completely different and mutually inconsistent value systems at work here, and neither one is necessarily better than the other. You're assessing a price on something that the other has already declared to be priceless.

Now who's more foolish in that discussion-- the person making the priceless claim, or those who choose to debate it with a completely different set of rules?

 

[RetireeRobert]

Sorry to be so obsessive about this, but it's not like the 'priceless' comment was directed towards how much we love our spouses, or our children - it was directed towards a financial transaction. And yes, we can put a price on those. ....-ERD50

My "priceless" comment was directed to what YOU keep thinking in terms of *only* being a financial transaction. The ones who "feel good" are not thinking only or primarily in financial terms. THAT is where the priceless comment was directed.

You previously stated the mortgage pay off or not pay off would only result in a "slight or maybe no net financial change".

So, if by your own statement, finances are in effect "irrelevant" to the payoff decision, why keep harping on finances as the desired basis for making the decision?

 

[youbet]

But when people say it (paying off the mortgage - or not) as if there iS some big rational financial benefit, well I'm trying to understand that. Is there some stone I left un-turned that explains this feeling? Maybe I'm missing something.

Sometimes there IS some big financial benefit to paying off a mortgage.

 

[ERD50]

Hey, you're preachin' to the choir.

I'm just suggesting that there are two completely different and mutually inconsistent value systems at work here, and neither one is necessarily better than the other. You're assessing a price on something that the other has already declared to be priceless.

Now who's more foolish in that discussion-- the person making the priceless claim, or those who choose to debate it with a completely different set of rules?

Well, I admit, this is getting to the point of being foolish, but there is something about it that just keeps bugging me.

'Different' I can accept - even if I disagree (like chocolate vs vanilla). It is the 'inconsistent' that is getting at me, I guess. I said before, if someone says they feel good regardless - fine, discussion is over, nothing to talk about.

But the sense I get, is that people say they feel good BECAUSE they feel they made some great financial achievement. That's the part I don't get.

It's like feeling better about paying an $8 bill at the checkout lane with a $20 - you get $12 back - whee! If you pay with a $10, you 'only' get $2 back! Is that a reason to be excited? Did it change your net worth? Should you be congratulated for your wise financial decision to pay the bill with a $20?

OK, obsession over - I'm tired. I can't imagine there is anything else to say (as the crowd cheers) .

-ERD50

 

[ERD50]

Sometimes there IS some big financial benefit to paying off a mortgage.

That's fine - that is not irrational. - ERD50

 

[clifp]

Wow a zillion posts on my one example. For me the paying off vs keeping mortgage, is pretty much strictly a financial decision. That said, I did pay off my mortgage (early) about 15 years ago on my first house. There was a psychologically benefit to being debt free and saying woo hoo I truly OWN my house.

However, I also understand the other side that people feel more secure with mortgage and having access to more liquid assets. I sometime wonder, why do have ~$700K tied up in house that is generating very little income (I do have a renter.)? I find myself wishing my mortgage was bigger.

It seems me that because people respond differently to debt that within a fairly wide range of mortgage there is no correct answer.

To Answer ERD50 question, how much is the peace of mind worth. FWIW, IMO if your mortgage is more than 1% below the risk free interest rate (which is not the same as a T-bill) there is no sense in paying off a mortgage. On the other hand if your mortgage is more than 2% above the risk free rate, having a mortgage is taking on unnecessary risk. In practical terms I think that for people with mortgages between 5% and 8% there is no universal right answer. That is my final answer.

 

[audreyh1]

You have a diversification problem. There are many ways to resolve that. Only one of them is paying off the mortgage. There are/were many other options.

-ERD50

I had a diversification problem. It was quite deliberate. But that was how I retired at 39, at which time I immediately resolved the diversification problem.

Audrey

 

[Nords]

However, I also understand the other side that people feel more secure with mortgage and having access to more liquid assets. I sometime wonder, why do have ~$700K tied up in house that is generating very little income (I do have a renter.)? I find myself wishing my mortgage was bigger.

I hear you on that one.

Landlording seemed like a good idea when the stock market was being sucked down the toilet by the NASDAQ and Hawaii real estate was bottoming out.

But now we're sitting on huge cap gains and pitifully low cash-on-cash returns that can be beat by dozens of Mainland locations. Reversion to the mean could kick in any day now on those cap gains, but selling is a hugely illiquid transaction with high costs and a massive AMT bite. It's a colossal hassle that's easy to contemplate and then decide to go surfing.

No wonder there's such a brisk business in 1031 firms around here that'll switch landlords over to Mainland TICs or even REITs.

 

[Khan]

You're trying to equate financial/quantitative decisions with emotional decisions.

A financial/quantitative decision would add up all the factors and compare them somehow to the emotional feeling of paying off the mortgage, and make a decision on that basis.

An emotional decision doesn't care about the financial/quantitative aspects of the issue.

You can argue about the financial/quantitative factors being ignored in an emotional decision, but it's irrelevant to the basis with which the person made the emotional decision.

You're trying to claim that the financial/quantitative basis for decision making is somehow better than the emotional basis for decision making. Your claim is only correct within the financial/quantitative perspective. To the person making the decision on an emotional basis, your perspective is irrelevant.

I'd recommend that you accept the existence of the phenomenon without trying to force it to fit within your view of the world!

It would appear he wants those of us with paid for houses to apologize and admit we are stupid and inferior.