Hi. Pay down mortgage or invest in TODAY's market ?

[free2020]

My idea is likely way off to the extreme side and is likely not what most will do.

Our home ownership experience over 30 years has been a mixed bag. Most like a dichotomy. We have had a lifetime of family fun in the houses we have owned. The value is priceless. But...

Financially speaking it has been an unmitigated disaster for most of the time. The first house we owned, we broke even. All others we have lost money on. The most recent one that we owned from 2002 to 2019 best captures the “unmitigated “ perfectly. Ironically in about the same time frame I have done extraordinarily well investing. I have learned some lessons. So here goes my conclusion,

Pay off our mortgage out of our estate, following the second death.

Rationale?

- put money into growing asset versus a declining one. Home ownership firmly belongs in the greater fool theory type. I have been the greater fool in each of our 4.
- Debt as a percentage of net worth most important; some absolute dollar amount isn’t.
- Interest rates are historically low. Let the bank own most of my house for as long as possible
- We live in a higher cost locale and the number of buyers for higher priced homes is forever declining.
- Any lack of sleep for me is based on slow but guaranteed mediocrity.

 

[BeachOrCity]

If your experience below is over 30 years then you most likely owned in areas experiencing flat or declining economic or population growth. Or you just had incredibly bad luck or purchased poorly. Absent the bubble, price growth pretty much fixed everyone’s housing returns as decent over 30 years

My idea is likely way off to the extreme side and is likely not what most will do.

Our home ownership experience over 30 years has been a mixed bag. Most like a dichotomy. We have had a lifetime of family fun in the houses we have owned. The value is priceless. But...

Financially speaking it has been an unmitigated disaster for most of the time. The first house we owned, we broke even. All others we have lost money on. The most recent one that we owned from 2002 to 2019 best captures the “unmitigated “ perfectly. Ironically in about the same time frame I have done extraordinarily well investing. I have learned some lessons. So here goes my conclusion,

Pay off our mortgage out of our estate, following the second death.

Rationale?

- put money into growing asset versus a declining one. Home ownership firmly belongs in the greater fool theory type. I have been the greater fool in each of our 4.
- Debt as a percentage of net worth most important; some absolute dollar amount isn’t.
- Interest rates are historically low. Let the bank own most of my house for as long as possible
- We live in a higher cost locale and the number of buyers for higher priced homes is forever declining.
- Any lack of sleep for me is based on slow but guaranteed mediocrity.

 

[ERD50]

... The first house we owned, we broke even. All others we have lost money on. ....
Pay off our mortgage out of our estate, following the second death.

Rationale?

- put money into growing asset versus a declining one. ...

While I agree that one should seriously consider keeping a mortgage and investing the difference if they have a good rate, the reasoning you site above is not valid.

The house value goes up/down independent of whether you have a mortgage or not. So it does not enter into the equation.

The equation is, can I reasonably expect my investments, at my desired AA, to outperform a mortgage over the long term? In most cases, that is a yes for periods over ~ 10 years. No guarantee, but in some cases it is a far better bet than most opportunities that we have available to us.

A more extreme example is that sometimes a car company offers a 1% loan. Well, that car will depreciate quite a bit by the end of that loan term. But I would take a 1% loan in a heartbeat (assuming no other strings). The car would depreciate anyway, so why give up this opportunity? Makes no sense that I can see.

-ERD50

 

[free2020]

While I agree that one should seriously consider keeping a mortgage and investing the difference if they have a good rate, the reasoning you site above is not valid.

The house value goes up/down independent of whether you have a mortgage or not. So it does not enter into the equation.

The equation ...

-ERD50

Look, I am dealing with my personal learning over 30 years. Not reading a statistic published somewhere. And I meet homeowners around me all the time.

Yes, I understand that me owning a mortgage is independent of the home value. Same is true of stocks and other assets. When I mentioned that I had done extraordinarily well in investing, this understanding has been at the core of it.

No, house value has not, does not / will likely not go up. For me, in my locale and in the kind of home I am living in. There is a depression in this kind of home market. Unlike 1929 or 2008, it is not a headline but a slow but sure mind numbing one.

 

[ERD50]

Originally Posted by ERD50 View Post
While I agree that one should seriously consider keeping a mortgage and investing the difference if they have a good rate, the reasoning you site above is not valid.

The house value goes up/down independent of whether you have a mortgage or not. So it does not enter into the equation.

The equation ...

-ERD50

Look, I am dealing with my personal learning over 30 years. Not reading a statistic published somewhere. And I meet homeowners around me all the time.

Yes, I understand that me owning a mortgage is independent of the home value. Same is true of stocks and other assets. When I mentioned that I had done extraordinarily well in investing, this understanding has been at the core of it.

No, house value has not, does not / will likely not go up. For me, in my locale and in the kind of home I am living in. There is a depression in this kind of home market. Unlike 1929 or 2008, it is not a headline but a slow but sure mind numbing one.

You lost me. What does your response have to do with a mortgage payoff/investment decision?

-ERD50

 

[arch57]

One item in haven’t seen mentioned in this thread increase in the standard deduction in the latest tax changes. Since that occurred I wasn’t able to deduct my mortgage interest and SALT so I used to discount my mortgage rate by the deduction it provided for us. Simple example a 4% loan in the 25% tax bracket was effectively a 3% loan.
Anyway we made a goal to pay ours off before retirement which made sense for our situation and no regrets.

 

[joeea]

No, house value has not, does not / will likely not go up. For me, in my locale and in the kind of home I am living in. There is a depression in this kind of home market. Unlike 1929 or 2008, it is not a headline but a slow but sure mind numbing one.

What locale is this?

In my locale, I've been fortunate enough to buy low and sell much, much higher each time.

 

[free2020]

What locale is this?

In my locale, I've been fortunate enough to buy low and sell much, much higher each time.

Chicago suburb. Mine has been unfortunately sell for less.

 

[Montecfo]

My idea is likely way off to the extreme side and is likely not what most will do.

Our home ownership experience over 30 years has been a mixed bag. Most like a dichotomy. We have had a lifetime of family fun in the houses we have owned. The value is priceless. But...

Financially speaking it has been an unmitigated disaster for most of the time. The first house we owned, we broke even. All others we have lost money on. The most recent one that we owned from 2002 to 2019 best captures the “unmitigated “ perfectly. Ironically in about the same time frame I have done extraordinarily well investing. I have learned some lessons. So here goes my conclusion,

Pay off our mortgage out of our estate, following the second death.

Rationale?

- put money into growing asset versus a declining one. Home ownership firmly belongs in the greater fool theory type. I have been the greater fool in each of our 4.
- Debt as a percentage of net worth most important; some absolute dollar amount isn’t.
- Interest rates are historically low. Let the bank own most of my house for as long as possible
- We live in a higher cost locale and the number of buyers for higher priced homes is forever declining.
- Any lack of sleep for me is based on slow but guaranteed mediocrity.

Even if you just broke even or even "lost" money you have to measure including the free rent and lifestlye value IMHO.

Also, just to be clear, when you pay dow a mortgage you are not investing in the underlying real estate. You already did that when you agreed to the purchase price. Instead you are investing in a synthetic bond with a coupon equal to the interest rate.

Looking at it as a bond alternative is I think quite valid. If you are not getting a tax deduction for your your interest, then it takes on more similarity to a synthetic muni bond since you do not lose tax benefits through paydown/payoff.

Of course, you should have adequate emergency cash in place before making the illiquid synthetic bond investment. If you have significant home equity, a standby HELOC is a good idea, IMHO.

Results may vary, contents may have settled, objects in the review mirror, etc.

 

[maybesomeday]

You only owe 40K so the interest is probably small, either way should be fine. I owe $235K, principal is about $2,600 and interest is $875 Monthly with about 7 years left. I will pay mine off in January as I retired this year. I still would owe about 65K in interest so paying off would save me that amount, if I tried to make 65K in 6-7 years with 235k might be a stretch, and that would be just to break even..

 

[Hamlet]

A mortgage acts as a negative on your total amount of bonds in your AA. So if you are 50/50 AA, say 1M Stocks and 1M Bonds, but you have a 500K mortgage, your actual AA is really 1M stocks and 500K bonds or 66/33.

Combine this with the fact that (most) people don't get the full value of the interest deduction anymore (new tax law) and you need to compare the after tax rates of returns on all of this.

Personally I would avoid the comparison w/ stock returns as it is not apples to apples, and instead compare to bond returns and look at your adjusted AA w/ the mortgage reducing it. View your liquidity now, and for ER until you can access tax deferred and make a decision.

Slightly different view than many, but hope this helps

This view makes a lot of sense to me. I've never thought it made sense to carry a mortgage while you own bonds yielding less than the mortgage rate ( once you take all of the tax implications into account ).

 

[ERD50]

This view makes a lot of sense to me. I've never thought it made sense to carry a mortgage while you own bonds yielding less than the mortgage rate ( once you take all of the tax implications into account ).

I don't think it makes sense to compare the mortgage rate to either bonds or stocks alone. Compare to your overall AA. Anything else is needlessly compartmentalizing. Your return is your total return of your entire portfolio.

Personally, I don't worry too much about a shift in AA, FIRECalc shows success rates to be pretty insensitive to AA, so I don't bother to adjust my AA when considering mortgage vs pay-off. Olus, my mortgage is a pretty small % of my portfolio, and that's probably the case for most considering a pay-off. But if you want to adjust your AA, IMO you should compare the pay-off vs your total portfolio return, before-aft.

edit/add: Another way to look at this - I don't hold fixed income because of a mortgage or not. I hold fixed to provide a buffer against a market downturn, so I could draw from fixed in a downturn, and/or have some dry-powder for re-balancing.

-ERD50

 

[joeea]

I don't think it makes sense to compare the mortgage rate to either bonds or stocks alone. Compare to your overall AA. Anything else is needlessly compartmentalizing. Your return is your total return of your entire portfolio.

Agreed!

 

[RetireAge50]

I don’t mind having a mortgage. Pay it like like a utility bill. Meanwhile, portfolio keeps increasing (and easily beating the 2.95% mortgage rate). I’m sticking with the formula.

 

[youbet]

In the end, if you want to, fine. If you don't want to, fine. I don't see either decision making or breaking a retirement here.

+1

Completely agree. For some reason, this pay off the mortgage or not question comes up rather frequently with the implication that it really matters. Unless your loan rate is high or you're plagued with that "I can't sleep at night knowing I have debt" syndrome, I agree that it really doesn't matter very much. Yawn........

 

[LRDave]

(I think) No one has mentioned that a low interest mortgage rate is also a great hedge in times of high inflation. Probably not a relevant factor in OP's case.

 

[youbet]

free2020:

We live in a higher cost locale and the number of buyers for higher priced homes is forever declining.

And that has been a problem in the Chicago suburbs lately. OTOH, my modest home in a blue collar neighborhood in west suburban Chicago has appreciated reasonably over the years. Nothing spectacular (about 4X in 43 years), but far from declining in value. In fact, at the last home owners association meeting a realtor gave a pitch saying there was actually a shortage of lower tier homes and prices for them were escalating. Apparently, according to this guy, builders have been focusing on larger, more expensive homes because margins are better.

 

[flintnational]

Yes, I know. Its a long post and I have posted similar comments before. But, it deserves repeating. This is a math/return analysis only. There are other reasons to have or not have a mortgage that I have not addressed.

Executive Summary - If your bond returns are less than your mortgage rate, financially you are better off to liquidate bonds and pay off the mortgage. The mortgage rate should be compared to your lowest returning asset. For most this will be bonds. Money is fungible.

Beating the dead horse -

If your bond returns are less than your mortgage rate, financially you are better off to liquidate bonds and pay off the mortgage. You increase your total return by the spread between the mortgage rate and the bond rate. If bonds pay more, the reverse is true and you should keep the mortgage. (This analysis ignores any tax implications of having a mortgage or selling bonds.)

With a mortgage
60/40 Asset Allocation
$600,000 Stocks
$400,000 Bonds
$1,000,000 Investable assets

$0 Home equity (100% mortgage)
$1,000,000 Net worth

Without a mortgage
100/0 Asset Allocation
$600,000 Stocks
$0 Bonds
$600,000 Investable assets

$400,000 Home equity (paid mortgage)
$1,000,000 Net worth

Where bond rates and mortgage rates are equal (say 3%), the two scenarios above have similar risk and return (assuming bonds and mortgages have similar risk). Some will argue the second example has a different asset allocation, 100/0 vs 60/40. But, that is only because we are not counting the paid off house in both examples. IOW, we are not comparing apples to apples. We are already counting home equity in the “With a mortgage” scenario. Once home equity is moved up to the investable assets, in the “Without a mortgage” example and counted as a bond, both scenarios have a 60/40 asset allocation. One example holds bonds. The other example holds a paid off mortgage. While most here do not normally include home equity in investable assets, it needs to be included in this situation to make a proper comparison since the mortgage example already includes home equity.

Finally, some are using total portfolio return compared to the mortgage rate. I believe this is a misstep. The mortgage rate should be compared to your lowest returning asset. For most this will be bonds. Money is fungible. I can hold bonds at 2% or I can use these funds to pay down a mortgage with a 3% interest rate. I do not have to liquidate stocks (or other high yield assets) to pay down the mortgage. From a math standpoint, it would only make sense to keep a mortgage when all of your assets have an expected return greater than the mortgage rate. Once again, money is fungible.

There are other reasons someone may wish to keep a mortgage or have a paid off house. The above only addresses the math/financial calculation and the way to equate the two choices for proper comparison. Additionally, an investor may not want to bring bonds all the way to zero since it would preclude rebalancing. Finally, the mortgage example likely provides more flexibility and liquidity. Once again, the above only considers the math and challenges the common assumption that total portfolio return is the proper measure against the mortgage rate.

I hope this helps.

 

[ERD50]

Yes, I know. Its a long post and I have posted similar comments before. But, it deserves repeating. This is a math/return analysis only. There are other reasons to have or not have a mortgage that I have not addressed.

Executive Summary - If your bond returns are less than your mortgage rate, financially you are better off to liquidate bonds and pay off the mortgage. The mortgage rate should be compared to your lowest returning asset. For most this will be bonds. Money is fungible.

Beating the dead horse -

If your bond returns are less than your mortgage rate, financially you are better off to liquidate bonds and pay off the mortgage. ...

OK, why not?

Well, your math is fine, but I don't think you have a real life situation there. At first, I was cutting you slack, as using extreme values is helpful to making a point. But I think this ends up cutting into making the point.

My issue is a $400,000 mortgage with $1M portfolio. If you assume a somewhat aggressive 4% WR, that's $40,000 from portfolio, and I would think a "pay off the mortgage for safety" type person would be using something more like 3.5%. So at least half of your income goes to mortgage, plus prop taxes on that value house, maintenance, so forth. Just isn't realistic, little else to live on.

OK, maybe they have other income, SS, pensions, annuities? Hmmmm, those are a lot like bonds, aren't they? So the mortgage holder could stay more fully invested in stocks with all those "bonds"? You came back and mentioned that you would want some bonds anyhow, for re-balancing, to pull from in a downturn, etc. So in a more real life situation, I don't think a typical scenario involves a need to change AA, at least not drastically.

Use a more realistic example, and assume no other income, so maybe $100,000 mort on $1M portfolio? The portfolio change either way does not scream to me that I need to change my AA. And if I did, let's see 60/40 with mortgage, (if I'm doing the math right) is ~ 67/33 with the mortgage. FIRECalc shows very, very similar results from portfolios in that range, so I think most wouldn't bother, and if they did, little effect anyhow.

... I hope this helps.

Yes, but probably not in the way you intended.

-ERD50

 

[flintnational]

OK, why not?

Well, your math is fine, but I don't think you have a real life situation there. At first, I was cutting you slack, as using extreme values is helpful to making a point. But I think this ends up cutting into making the point.

-ERD50

ERD - I believe you and I are in agreement. I am using your post to further elaborate on this topic for those that may be following. So, while I address your points, some of this is just restating what I said earlier and not directed toward you since it appears we agree on the math................

Good morning. Yes, there are several important considerations beyond the math, which you and I both mention. But I am only addressing the math.

My only point is summarized in this paragraph. - The goal of my previous post is to counter those that have indicated their portfolio return is greater than their mortgage rate and therefore they are ahead financially by keeping the mortgage (a math based statement). I suggest they are not handing the math correctly. Total portfolio return should not be the metric. The lowest yielding asset (most likely bonds) should be used for a comparison to the mortgage rate.

First, you are correct about the numbers simply being an example*. Pick any values you like for stocks, bonds and the mortgage. The math remains the same. If bonds yield less than the mortgage rate, from a math/financial standpoint, you are better off liquidating bonds and paying off the mortgage. If bonds, yield more, you are better off keeping the mortgage. And, as the example shows, you are not changing the asset allocation once both examples get credit for home equity. The allocation is only changed if you count the invested home equity in one example and fail to count it in the other.

I acknowledge there are many reasons to have or not have a mortgage unrelated to the math in this example. You get into those reasons. All valid, but not what I am analyzing. None of those reasons change the math. And, since many are attempting to base this decision on the math, or at least use the math as a starting point, I believe it is important to show the proper way to analyze the numbers. Once we have a handle on the math, we can then factor in the other reasons that should influence our decision.

*In my example I picked $1M since it is a easy number to follow in the example. I then picked a common AA of 60/40 to make the point. I used bonds and the mortgage at the same 40% value to show they are interchangeable. This seemed to be the easiest math example. A more realistic example would be a $2M net worth at 60/40 and a home value of $250k. But, when that example is shown it looks more complicated and obscures the points being made. However, the math does not change.

 

[pb4uski]

Yes, I know. Its a long post and I have posted similar comments before. But, it deserves repeating. This is a math/return analysis only. There are other reasons to have or not have a mortgage that I have not addressed.

Executive Summary - If your bond returns are less than your mortgage rate, financially you are better off to liquidate bonds and pay off the mortgage. The mortgage rate should be compared to your lowest returning asset. For most this will be bonds. Money is fungible. ....

This is only "right" when someone uses the proceeds from the sale of fixed income investments to pay off their mortgage so in effect their AA is changed to be higher in stocks and lower in fixed income.... or the same where the mortgage is included as a negative fixed income investment.

However, where the person keeps the same AA (intentionally or unintentionally) then the rate of return to use to compare to the mortgage rate is the expected return for that asset mix or on the assets that will be liquidated to pay off the mortgage.

 

[flintnational]

This is only "right" when someone uses the proceeds from the sale of fixed income investments to pay off their mortgage so in effect their AA is changed to be higher in stocks and lower in fixed income.... or the same where the mortgage is included as a negative fixed income investment.

However, where the person keeps the same AA (intentionally or unintentionally) then the rate of return to use to compare to the mortgage rate is the expected return for that asset mix or on the assets that will be liquidated to pay off the mortgage.

I know you are concerned that folks hold their AA the same when they pay off the mortgage. And, if that is the case, you are correct. My point is simply that would be a sub-optimal decision. They could have chosen to use only lower yielding bonds to pay off the mortgage. And, you and I agree that the if the examples are compared properly, treating the mortgage as a negative fixed income investment, the AA stays the same by using bonds exclusively to pay down the mortgage.

As always, I think you make the point more succinctly than I do.

 

[mystang52]

Isn't it "unfair" to compare mortgage obligation with potential return from stock investing? A mortgage is a legal payment obligation, and solely in theory one can lose 100% if invested in stocks, That being the case, wouldn't someone have to keep mortgage principal in safer investments such as bonds? Then the issue becomes bond return vs mortgage interest rate.

 

[flintnational]

Isn't it "unfair" to compare mortgage obligation with potential return from stock investing? A mortgage is a legal payment obligation, and solely in theory one can lose 100% if invested in stocks, That being the case, wouldn't someone have to keep mortgage principal in safer investments such as bonds? Then the issue becomes bond return vs mortgage interest rate.

I agree. That is the reason I showed bonds, home equity and the mortgage interchangeably. From a risk standpoint they are similar. And, as you suggest, if they are similar, we should only compare the bond yield to the mortgage rate. To do otherwise, changes the AA and the risk profile of one or the other examples.

But, I get pb4,s point. The reverse can also happen. If someone holds their AA the same and pays off the mortgage from a mix of stocks and bonds, they are likely being less efficient. They would need to treat the mortgage as a negative bond and pay off the mortgage solely from bonds.

 

[ERD50]

ERD - I believe you and I are in agreement. ...The lowest yielding asset (most likely bonds) should be used for a comparison to the mortgage rate. ...

No, we are not in agreement where it comes down to what really matters, real life.

We may be in agreement on the math, but I am not in agreement with the application of that math.

// from a reply to pb4uski // ... I know you are concerned that folks hold their AA the same when they pay off the mortgage. ....

I don't see it as a 'concern', I think that in real life, most people do not adjust their AA, or do only a small adjustment (like my eaxmple, 60/40 to 67/33?) that probably has no effect on what they can draw from their portfolio, or the portfolio safety (neither of which is super-sensitive to moderate AA changes between ~ 35/65 95/5).

Isn't it "unfair" to compare mortgage obligation with potential return from stock investing? A mortgage is a legal payment obligation, and solely in theory one can lose 100% if invested in stocks, That being the case, wouldn't someone have to keep mortgage principal in safer investments such as bonds? Then the issue becomes bond return vs mortgage interest rate.

I know this "mortgage pay-off is 100% safe" view comes up, and again, mathematically it seems valid. But I really don't think it matters to most. The only case I can think of where I think it would be a legitimate comparison is this - if before paying off the mortgage, the person was holding that amount in treasuries of a duration matching the mortgage term, or in an FDIC MM, CD etc. That money could be considered as safe as it gets.

But who does that? Very few, I would think, especially at the level in your example, 40% in "safe" investments?

So sure, the mortgage pay-off can be viewed as 'safe', but the way I see it, that is just how it works, it wasn't part of some strategy or goal... unless this person had that money "safe" while holding the mortgage, as I described. It just sort of goes along for the ride. If that 'safety' was not a concern before, why is it now? Doesn't make sense to me.

-ERD50