Pay off mortgage

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big-papa

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Howdy from Texas. I bet this is a common question and I'm sure it's in one of the forums already but I couldn't find it.

Lots of websites out there on the subject but none appear to do a complete analysis on whether/when one should pay off a mortgage. My own incomplete analysis that ignores taxes shows that for the size nest egg we have and the amount of principal left on the loan, the reduction in the nest egg is more than offset by the reduction in the overall annual budget.

Again this ignores taxes, so a payoff increases taxes because we're probably back to the standard deduction. At any rate, there is a point in the life of the loan where all of our deductions, including interest, fall below the standard deduction.

I'm not talking about raiding 401Ks or rollover IRA's - just wondering if somebody out there has or knows of a spreadsheet or tool that takes this into account when calculation withdrawal rates.




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This has been discussed MANY times... I am sure someone will links some prior threads, but not me...

There is basically two sides that from what I can tell by prior posters is evenly split (but I do not remember seeing a poll..... hmmmm...)...

Pay off mortgage and have a lower budget...

Do not pay off mortgage and have more to invest which (probably) will earn more than the interest rate you pay...


Now, taxes comes in for some, but not all.... the standard deduction is getting up there and is not a factor for the vast majority of people....


But, you fall on the 'pay it off now' side or the 'keep paying' side and I have not heard anybody change sides since I got here....
 
You know, i've always been of the mindset that when i am ready to pay down the mortgage, i will pay into my taxable investments accounts until
The sum saved equals the remaining mortgage principal. This way i have options available to me and can pay it off all at once or change my mind, and likely i don't lose out on growth.


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big-papa said:
Lots of websites out there on the subject but none appear to do a complete analysis on whether/when one should pay off a mortgage.
Click to expand...

To do a complete analysis, you'd also need to model your investment portfolio since you are taking a chunk out of that to eliminate a steady stream of expenses. I think some/many of the retirement calculators can do this -- maybe look at fidelity's or i-ORP. It probably can be done in Firecalc too (if you get creative on the other income/spending tab).
 
Lots of discussion on this topic over the years but I've never seen any convincing evidence one way or the other. The devil is in the details as defined by your own personal circumstances and your psychological makeup.

Bottom line - do whatever makes you sleep best at night.
 
I sort of suspected that it was discussed quite a bit already. Good to hear from some fellow Texans, too!

Certainly, comfort level must come into play, but I would think that there would be some calculations somebody has come up with that includes tax situation, where one is in the life of the loan (amount of principal vs interest), returns expected if the money is invested instead and the total principal remaining relative to the entire size of the nest egg.


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Any "complete" analysis must also account for taxes.


But there is also a bit of crystal ball effect if you play the what if returns are "x" for carrying the balance against portfolio performance.


You could at least bracket the scenario, then make your decision.
 
My wife has perennially pointed out the 'tax advantage' of deductible mortgage interest, but, being a bear-of-little-brain, I just don't get it. My view: For every dollar you pay in mortgage interest, you then subtract a dollar from your taxable income to decrease your tax burden by, say, 28 cents depending on your tax bracket. So, if you didn't have to shell out that dollar for interest, your increased tax burden would come out of that dollar saved so you'd be 72 cents ahead...? This ignores the time-value of money, but even then I don't see even an approximate advantageous situation unless the tax rate becomes ridiculously high.

There are some very smart folks posting here, and at least a few quite savvy on tax considerations, so I'll be very interested to see the discussion as I have never gotten it. All I can motivate myself to do in this regard is to pay off while I'm working the house we intend to live in well into retirement, so the mortgage doesn't show up as an expense after I quit working. Oh, and we did that years ago, accelerated payments on a 15-year mortgage. Saved us a coupla hundred thousand in interest expense.
 
I did a bit of analysis before paying off my $188K mortgage, at 5.5%, with ~26 years left on it. It was an investment property. I wanted cash flow, not leverage going into retirement.

Which is better, saving $1 in interest, or saving $.30 in taxes.

The next question was, Is a 100% guaranteed 5.5% return better than the return of the market?

What are the other investment vehicles, when adjusted for risk, that perform better?

Of course, a crystal ball would have helped.
 
Funny, in the 15 minutes it took me to post my little tirade, 5 others weighed in, and now I think I see what you're looking at: How does the reduced earning potential of your nest egg weigh against the perceived 'tax income' gained by metering out interest payments from the nest egg...? Phrased that way, a scenario-based spreadsheet shouldn't be too tough to construct.
 
Yep, it appears that like so many things, the answer depends on assumptions. One website, mortgage professor, prefers to compare mortgage interest against investments of similar risk such as CD's and bonds as he considers that closer to apples-to-apples. That gets you one answer. He also allows that one may compare against a stock/bond allocated portfolio as well, but points out the concerns of volitility. That may get you another answer but you'll need to guess at future returns - not that many of us don't already do that for other reasons already. Oh, and then there are guesses about inflation too.

http://www.mtgprofessor.com/A - Early Payoff/When should seniors prepay.htm





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big-papa said:
Yep, it appears that like so many things, the answer depends on assumptions. One website, mortgage professor, prefers to compare mortgage interest against investments of similar risk such as CD's and bonds as he considers that closer to apples-to-apples. That gets you one answer. He also allows that one may compare against a stock/bond allocated portfolio as well, but points out the concerns of volitility. That may get you another answer but you'll need to guess at future returns - not that many of us don't already do that for other reasons already. Oh, and then there are guesses about inflation too.

Pros and Cons of Mortgage Prepayment by Seniors - The Mortgage Professor

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Click to expand...

Now, THAT is a very useful post; thanks, big-papa.

What I do now get is, for either of the alternatives you face different uncertainties. So now, I view my approach as risk avoidance, in that I nailed my rate of return by pre-paying, rather than leaving it to a market I had yet to experience. Given my investment prowess, pre-paying was a good decision... :D

As I've planned my retirement, I've increasingly moved my attention from rate-of-return considerations to risk-avoidance considerations. So, it's index funds for me, but they're just one of four income sources, each with very different exposures to undesired outcomes.
 
I know this already appears over from your perspective, but as I try not to reply, I'm still pecking away.

I have a 3.5% loan on my home. My analysis for MY SITUATION covers several ways to view this. First, I can afford the payments without impacting the chance that we outlive our savings. Even with this cost in our budget we still get to 100% with various tools.

1) if I pay off the mortgage, I earn 3.5% on my $$. If I pay as scheduled, I should be able to earn 6% in a mixed 60/40 portfolio. Advantage mortgage.

2) Mom is worried about things she shouldn't and worries more as she matures. I would be foolish to think this will not happen to me as I reach her age. One option would be as we reach that point where we worry needlessly. Advantage mortgage.

3) If something happened where we needed $$, and we paid off the house, once in need we would be in a poor position to borrow at a decent rate. Advantage mortgage.

4) If inflation were to pick up, say 3.5% and our investments were to keep up or stay ahead of it, our Cola adjusted pensions would throw off more $$. Advantage mortgage.

5) Proverbs says neither a borrow'r or lender be - advantage pay off the home

That is what sounds reasonable to me, buy as you have seen, doesn't to many of the smart folks on this board. Maybe I'm already at that mental loss point.

Best of luck with your choice.
 
Hi retireby90 - I can clearly see what your mean and how it could apply. For me, though, no pension, so that eliminates one of them. For two of them I think the answer is going to depend on how far along somebody is on their mortgage. If I'm 15-30 years away from finishing payoff as scheduled, I'm a lot more confident that I can get a return that exceeds the interest rate (assuming I live that long) than I would be with only a few years left. But you've given me more to consider - thanks!


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RetireBy90 said:
I know this already appears over from your perspective, but as I try not to reply, I'm still pecking away.

I have a 3.5% loan on my home. My analysis for MY SITUATION covers several ways to view this. First, I can afford the payments without impacting the chance that we outlive our savings. Even with this cost in our budget we still get to 100% with various tools.

1) if I pay off the mortgage, I earn 3.5% on my $$. If I pay as scheduled, I should be able to earn 6% in a mixed 60/40 portfolio. Advantage mortgage.Interesting thoughts... Should be able to and actually earning are VERY different things. Wouldn't be advantage mortgage in my book

2) Mom is worried about things she shouldn't and worries more as she matures. I would be foolish to think this will not happen to me as I reach her age. One option would be as we reach that point where we worry needlessly. Advantage mortgage.Again not certain the logic here. I would be less worried knowing my housing was taken care of and my needed income stream was less: YMMV

3) If something happened where we needed $$, and we paid off the house, once in need we would be in a poor position to borrow at a decent rate. Advantage mortgage.I guess this is true if you are already retired; but, if your house is the major piggy bank, probably need to continue working at which point this isn't such a strong argument.

4) If inflation were to pick up, say 3.5% and our investments were to keep up or stay ahead of it, our Cola adjusted pensions would throw off more $$. Advantage mortgage. Huh? I am having trouble understanding what paying off your mortgage has to do with the pension $$'s. Maybe I just missed something

5) Proverbs says neither a borrow'r or lender be - advantage pay off the home



That is what sounds reasonable to me, buy as you have seen, doesn't to many of the smart folks on this board. Maybe I'm already at that mental loss point.

Best of luck with your choice.
Click to expand...

As has been noted above, this seems to be more a philosophical discussion. Choose the option that let's you sleep at night. In case you can't tell, my home is paid off.:cool:........
 
I paid off my mortgage a couple years ago.

I think the Prof's point about comparing mortgage payoff to CDs or T-Bills is right on because you're comparing similar risk levels...not a guaranteed thing vs. a volatile thing. (I once heard Warren Buffet say "A guaranteed good thing beats a maybe great thing every time.")

If I had put the $400K it took me to pay off the mortgage into the market instead, I'd be way ahead right now. If the market implodes tomorrow, the payoff would look like a better deal. History says that over time, you will be compensated for your risk with a higher rate of return and that if you have time and balance sheet/income cushion you should keep the house levered and soak up the higher return. History also said that the real estate market couldn't implode nationwide at the same time. So much for history ;-)

Regardless, I'm happy I paid it off even if my balance sheet says I shouldn't be. For me, I try to remember that life isn't a balance sheet exercise and sleep counts. I'll always need a roof over my head and I tend to think of that as "covered" now because if I want to move I sell this one and use the balance to buy the next one (less transaction costs which would happen regardless of the status of the mortgage). With no mortgage, the future me won't have to create income to pay the mortgage which lowers the hurdle to a lot of things -- and it makes LBYM almost a certainty even if I got whacked and had to take a lower paying job.

That was my decision and I'm glad we did it. Whatever you do, just be sure you're comfortable with it. Remember that this is a high class problem -- there really isn't a bad outcome here. At WORST you own your home free and clear and sub-optimize some future gains. My $0.03.

Good luck.
 
In response to robertf57 -don't want to argue one way or another, just wanted to present one more way to consider the OP choice. Having said that, I wanted to make one attempt in non-bold response if it helps the thought process for others. You and I have already made our choices.

1) if you are investing savings for your future retirement, you must make some assumptions about returns. I've made what I believe is a conservative but realistic assumption of 6%. Not sure what value you would put on a pile of money that could be invested or used to pay off your mortgage.

2) What I'm saying is that this is a potential problem down the road, if I have a pile of $$ and a mortgage, I have the option. If I have no $$ and no mortgage, not as many options.

3) This obviously isn't the case here, as the discussion is to take some of a pile and pay off the house.

4) I did a poor job on this one. One advantage (in my way of thinking) of a mortgage is that it doesn't change with inflation. Rent goes up most years, but a traditional mortgage doesn't change. If you get a raise with inflation, as I will with COLA adjusted pensions, the mortgage payment becomes less and less of a percentage of the pension. So if I receive $1,000 per month today, and have a mortgage of $1,000 then my pension covers my mortgage and no more. In 10 years, with 3% inflation, my pension should be about $1,400 but my mortgage is still $1,000 or 71% of my pension. From nothing left to $400 per month left.
 
All of my lifetime big decisions have been based on the sleep-at-night factor. When I had about 5 years left on my mortgage, the tax break was negligible and the remaining principal was not that large. I didn't do any major mathematical/actuarial calculations.
But I knew I'd feel emotionally better paying off that mortgage. I have never regretted that decision, and in fact not having a mortgage made the ER decision a lot easier. That emotional lift is not one to disregard in your decision process.
 
Another factor people often fail to consider is what is done with the money you would use to make the mortgage payment if you did pay it off. When I paid off my mortgage four years ago the money that would have been my interest payments was invested, so those investment earnings build over time and can be added to the immediate interest savings from the mortgage payoff. Personally I just couldn't see paying the interest and chose the security of paying off my home. If the economy enters a deflationary stage, I'd hate to have a mortgage with declining values as many did a few years ago.


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Dash man said:
Another factor people often fail to consider is what is done with the money you would use to make the mortgage payment if you did pay it off. When I paid off my mortgage four years ago the money that would have been my interest payments was invested, so those investment earnings build over time and can be added to the immediate interest savings from the mortgage payoff. Personally I just couldn't see paying the interest and chose the security of paying off my home. If the economy enters a deflationary stage, I'd hate to have a mortgage with declining values as many did a few years ago.


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Click to expand...

Good point, you will have a stream of payments to invest, so the advantage of higher return would decrease over time.
 
I'm probably an anomaly in that I did an 80% cash out refi a couple weeks before I retired a few years ago. I dropped my rate from 4.375% to 3.375% (both 15 year mortgages) and I figured that would be my last/best chance at "cheap' money. I figure if I can't beat 3.375% then having a mortgage will be the least of my worries. So far it has worked out well as my portfolio return since I took out my mortgage has been 11.82% annually so things would have to go bad in a big way for me to come out behind so my timing was good with 20/20 hindsight.

I think carrying a mortgage in retirement is easier if it is relatively small (ours is less than 10% of our net worth at the time we took it out).
 
Without quoting anybody I will make a few comments on some of the posts...

Some say to make a comparison to CD or Treasury rates... I say this is wrong.... You have an AA that you have picked... if you pay off the mortgage with your CDs, then you will have too much invested in stocks and you will sell some to get back to your AA.... the real rate to compare is an anticipated rate on your AA...


Someone quoted about feeling better with having a paid off house if the market goes down.... what does it matter:confused: If you do not plan on moving, you just keep making your payments and ignore the value of the house.... it might have an emotional effect, but in reality there is nothing different in the two ways....



The reality is that since the market usually does better over a 15 or 30 year time frame, having a mortgage has more advantages financially than not having a mortgage.... if interest rates go down, you can refi and take advantage of those lower rates.... if interest rates go up, then you earn more on your investments... IMO, paying off the mortgage is a emotional decision which cannot be modeled... that is why it is so hard to find any that really make sense, because they do not make sense...

It think it was REWahoo that said do what makes you sleep better at night... that is the big decision (If I said the wrong person... sorry)...
 
Hi Texas proud
I don't think the mortgage professor was saying to pay off the mortgage with bonds or cd's. He was saying that an apples-to-apples comparison of paying off a mortgage at a certain interest rate should be compared to the returns of an investment of equal risk - cd's and bonds being those vehicles.

Now you're right, from a practical standpoint, many of us would be pulling $ to pay off a mortgage from an AA that is most likely stocks/bonds. To me, that's when taxes and the amount of time left on the note comes into play as well as inflation (which means real returns) since a standard mortgage won't change with inflation, but your effective returns from your AA will.


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With a paid off home I feel like I can have a bit more aggressive AA than I would if I had to come up with a mortgage payment every month. So, I'm more in favor of comparing a mortgage to a more conservative investment as a personal viewpoint.

A different factor for some to consider, if you are in ER and have the bulk of your savings in tax advantaged accounts, keeping a mortgage that extends beyond age 59.5 can make sense to bridge the gap until you can access your 401K/IRA, pension and SS money.
 
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