Mortgage Payoff vs Taxable Account - What else should I consider?

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Topic Author
Scooter K
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Joined: Thu Jun 08, 2017 1:38 pm

Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

Hello,

I've been considering two alternatives and really need a second opinion in case there's something I'm missing in the following scenario.

My wife and I have just refinanced our mortgage to a $640,000 on a 7/1 ARM at 2.125%. It will adjust in May 2028, and since that adjustment will almost certainly be upward, we're setting that date as our target to have the mortgage paid in full. It's not like 100% necessary to have it paid off, just a good goal we're shooting for.

(Option A): Pay an additional $5800 per month towards the principal on the mortgage and it will be paid off exactly in May 2028.

(Option B): Instead put that extra $5800 per month in a taxable account, investing simply in Vanguard's Total Stock Market and International Index Funds and taking the market returns for the next seven years, using the proceeds to (hopefully) pay off the mortgage in 2028.

I'll give you more information about our financial situation, as it could influence the decision on how much risk to take. We have a goal of early retirement in the 2030-2035 range, once we're around $2.5m in net worth.

Assets:
Her 401(k): $77k pretax, company profit sharing contributes about 50k/year automatically to this account (she's been employed 1.5 years).
Roth IRAs: $422k, backdoor Roth done for 2021, planning on doing this each year going forward.
HSA: $20k, maxing out each year as a stealth IRA.
Emergency Fund: $45k (fully funded for us)
Primary Residence: ~$900k
Take Home Pay: ~200k

Liabilities: $640k mortgage, no other debt.

I'm 41 and she's 36, we'll need a bridge fund if we stop working before regular retirement age, which we haven't started building yet.



My Arguments in Favor of Option A:
In my experience, I've never regretted the "boring option" of paying off debt. There's no chance I'll accidentally buy a boat or an RV with money that's supposed to go to the mortgage in this option. And, there's certainty in knowing we'll have the mortgage paid off by our target date. Perhaps we'll sleep better having more certainty about the outcome.

My Arguments in Favor of Option B:
The interest rate on the mortgage is likely pretty close to the inflation rate. Seven years isn't super long term, but it's not really short term either; so it seems very likely over seven years that the index funds mentioned above would outpace inflation. Potentially, we'd be ahead by $50k-$300k. With nominal returns of 8%, we'd be ahead around $110k after accounting for taxes on LTCG. Basically the market would just about need to have a negative real return over the next seven years for this Option to turn out badly.
Additionally, this option starts us building the bridge fund we'll need during early retirement, and I'm confident that even in the worst case scenario (something like our $600k investment turns into $400k?) we'd be fine -- maybe have to work an extra two years beyond what we had planned.

So Option B is something like 80% likely to leave us more wealthy seven years from now, and in the 20% downside scenario, we can afford the risk.

However, my wife has always been more conservative with money and investments and is a super saver. I've always been more likely to take risks, though I'm a good saver I know I can talk myself into plans that I want to work and downplay the risk.


My feeling is that this isn't really a close call, and we should just go Option B and stick to the plan come hell or high water. But what else should I consider?

Thanks for your comments in advance, and please let me know if there's anything I can clarify.

Scooter
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
Monsterflockster
Posts: 686
Joined: Thu Nov 21, 2019 12:03 am

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Monsterflockster »

Scooter K wrote: Sun Apr 11, 2021 5:19 pm Hello,

I've been considering two alternatives and really need a second opinion in case there's something I'm missing in the following scenario.

My wife and I have just refinanced our mortgage to a $640,000 on a 7/1 ARM at 2.125%. It will adjust in May 2028, and since that adjustment will almost certainly be upward, we're setting that date as our target to have the mortgage paid in full. It's not like 100% necessary to have it paid off, just a good goal we're shooting for.

(Option A): Pay an additional $5800 per month towards the principal on the mortgage and it will be paid off exactly in May 2028.

(Option B): Instead put that extra $5800 per month in a taxable account, investing simply in Vanguard's Total Stock Market and International Index Funds and taking the market returns for the next seven years, using the proceeds to (hopefully) pay off the mortgage in 2028.

I'll give you more information about our financial situation, as it could influence the decision on how much risk to take. We have a goal of early retirement in the 2030-2035 range, once we're around $2.5m in net worth.

Assets:
Her 401(k): $77k pretax, company profit sharing contributes about 50k/year automatically to this account (she's been employed 1.5 years).
Roth IRAs: $422k, backdoor Roth done for 2021, planning on doing this each year going forward.
HSA: $20k, maxing out each year as a stealth IRA.
Emergency Fund: $45k (fully funded for us)
Primary Residence: ~$900k
Take Home Pay: ~200k

Liabilities: $640k mortgage, no other debt.

I'm 41 and she's 36, we'll need a bridge fund if we stop working before regular retirement age, which we haven't started building yet.



My Arguments in Favor of Option A:
In my experience, I've never regretted the "boring option" of paying off debt. There's no chance I'll accidentally buy a boat or an RV with money that's supposed to go to the mortgage in this option. And, there's certainty in knowing we'll have the mortgage paid off by our target date. Perhaps we'll sleep better having more certainty about the outcome.

My Arguments in Favor of Option B:
The interest rate on the mortgage is likely pretty close to the inflation rate. Seven years isn't super long term, but it's not really short term either; so it seems very likely over seven years that the index funds mentioned above would outpace inflation. Potentially, we'd be ahead by $50k-$300k. With nominal returns of 8%, we'd be ahead around $110k after accounting for taxes on LTCG. Basically the market would just about need to have a negative real return over the next seven years for this Option to turn out badly.
Additionally, this option starts us building the bridge fund we'll need during early retirement, and I'm confident that even in the worst case scenario (something like our $600k investment turns into $400k?) we'd be fine -- maybe have to work an extra two years beyond what we had planned.

So Option B is something like 80% likely to leave us more wealthy seven years from now, and in the 20% downside scenario, we can afford the risk.

However, my wife has always been more conservative with money and investments and is a super saver. I've always been more likely to take risks, though I'm a good saver I know I can talk myself into plans that I want to work and downplay the risk.


My feeling is that this isn't really a close call, and we should just go Option B and stick to the plan come hell or high water. But what else should I consider?

Thanks for your comments in advance, and please let me know if there's anything I can clarify.

Scooter
And in 7 years what if the market tanks and sees a decade of stagnation and doesn’t climb out?

Essentially you’re market timing and gambling that the market will be up in 7 years. It’s likely but not guaranteed. Can you handle the risk?
babystep
Posts: 418
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by babystep »

How about Option C) 50/50?

$2900 towards Option A) and $2900 Option B).
Triple digit golfer
Posts: 7460
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Triple digit golfer »

I would absolutely not count on equity markets returning anything over such a short time period. If you said 20 years I'd say investing is probably the right thing from purely a financial perspective.

An important point that shouldn't be glossed over is your comment about not buying a boat or RV. If you have even the slightest bit of doubt that you'd be disciplined, put the money to the mortgage regardless of time period or interest rate.

I vote for mortgage paydown in this situation.
invest4
Posts: 355
Joined: Wed Apr 24, 2019 2:19 am

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by invest4 »

At current interest rates, I would have proposed a 30 year mortgage to provide more in the way of options for you.
Topic Author
Scooter K
Posts: 41
Joined: Thu Jun 08, 2017 1:38 pm

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

Monsterflockster wrote: Sun Apr 11, 2021 5:25 pm
And in 7 years what if the market tanks and sees a decade of stagnation and doesn’t climb out?

Essentially you’re market timing and gambling that the market will be up in 7 years. It’s likely but not guaranteed. Can you handle the risk?
I guess I feel like it's market timing if I need the money in a year, but on a longer time horizon when we don't NEED the money, is that still market timing? If the market tanks and sees a decade of stagnation, that would be awesome, we'd put in another million dollars in investments over that decade at discount rates.

I'm not trying to be glib, just grappling with the idea that this is market timing. It is in the sense that I'd be putting money in each month for seven years and then more or less taking it out (though probably we'd take half out in the end of 2027 and the rest in 2028, to spread out the taxes due). But then isn't everything market timing? You're putting money in at some time and taking it out some time later, right?


To answer your question, if the market tanks and sees a decade of stagnation and doesn't climb out, I'd take a deduction for our capital losses and we'd have to work an extra year to pay off the house.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
Topic Author
Scooter K
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Joined: Thu Jun 08, 2017 1:38 pm

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

babystep wrote: Sun Apr 11, 2021 6:11 pm How about Option C) 50/50?

$2900 towards Option A) and $2900 Option B).
I think this is probably what we'll end up doing. I'll be half happy, one way or the other. Thank you for thinking of Option C!
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
gideon trumpet
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by gideon trumpet »

I disagree with the responses suggesting that Option B is akin to market timing or a short-term (7-year) bet on market returns. It sounds like you do not need this money in seven years, so you would continue to hold the investments made during this period. In other words, the return on equity may not be realized at year seven, but you would likely get that return eventually.

I do agree that if you really think you're going to ditch the plan and splurge on something instead of invest that is a different issue. In that case, paying down the mortgage is like paying for a lack of liquidity to protect yourself from your own spending habits. (But is that really a risk in your situation? It doesn't sound like your spouse would let it happen.)

That said, it sounds like your spouse prefers paying down the mortgage. Maybe a compromise would work best for you both? Put half the extra funds toward the mortgage, invest the rest, and reevaluate in five years?
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

Triple digit golfer wrote: Sun Apr 11, 2021 6:23 pm I would absolutely not count on equity markets returning anything over such a short time period. If you said 20 years I'd say investing is probably the right thing from purely a financial perspective.

An important point that shouldn't be glossed over is your comment about not buying a boat or RV. If you have even the slightest bit of doubt that you'd be disciplined, put the money to the mortgage regardless of time period or interest rate.

I vote for mortgage paydown in this situation.
I don't think I'd buy a boat, but just thinking about different risks the money is definitely more liquid in a taxable investment account, and de facto more tempting. It's also more available if a genuine emergency that isn't covered by our emergency fund were to occur, which might be an upside.

Thanks for your vote, I'm counting it in the Option A column, and appreciate your time and input!
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
Topic Author
Scooter K
Posts: 41
Joined: Thu Jun 08, 2017 1:38 pm

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

gideon trumpet wrote: Sun Apr 11, 2021 6:49 pm I disagree with the responses suggesting that Option B is akin to market timing or a short-term (7-year) bet on market returns. It sounds like you do not need this money in seven years, so you would continue to hold the investments made during this period. In other words, the return on equity may not be realized at year seven, but you would likely get that return eventually.

I do agree that if you really think you're going to ditch the plan and splurge on something instead of invest that is a different issue. In that case, paying down the mortgage is like paying for a lack of liquidity to protect yourself from your own spending habits. (But is that really a risk in your situation? It doesn't sound like your spouse would let it happen.)

That said, it sounds like your spouse prefers paying down the mortgage. Maybe a compromise would work best for you both? Put half the extra funds toward the mortgage, invest the rest, and reevaluate in five years?
Yeah, I might have oversold my potential for a boat. The truth is, we live on a written budget and have planned, spent, and tracked every purchase we've made since 2011. There's not gonna be a surprise boat.

I don't think we need the money in seven years, but I think we'd pay off the mortgage then if the brokerage account balance exceeded the mortgage account balance. If it went badly and we fell short by $100k or something, not the end of the world. If it went well, which historically speaking most 7 year periods do better than 2.1% nominal, that'd be icing on the cake.

I think it comes back to a classic question of: If you could borrow a million bucks at 0% interest would you do so and invest it in the market? I think we could, but I don't know if we should or not? Eat better, or sleep better?

Another vote for Option C (50/50), sounds prudent. Thank you!
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
KlangFool
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by KlangFool »

OP,

1) You are not conservative. You have a 900K house and 450K investment outside the house. You are "house poor" asset wise. What if the house crash 50% and do not recover for 10 years, then, what would you do?

2) It is not safe to put more money into the house. Hence, why do you think it is safe and make sense to pay off the mortgage in 7 years? You are "market timing" that the house will worth 900K or more in 7 years. And, that is 50% or more your net worth.

3) I vote for option (D).

A) Refinance to 30 years mortgage. Then, you do not need to "market time" that the house will not crash and you need to sell at the wrong time. This is a 900K house and 50% of your net worth. It is a huge RISK.

B) Invest as per your asset allocation and allocate 100% stock into your taxable account.

4) Do not keep most of your eggs in the "house" basket. Housing market has a very long cycle. And, you are taking a huge RISK on a single 900K house.

KlangFool
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as9
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by as9 »

With interest rates so low I’m not sure why you wouldn’t lock in a fixed rate so you don’t have this looming deadline. Given the excess you have each month you could debate the merits of a 15 year vs 30.

If that’s a non-starter for some reason then I’d go with B or C.
LittleMaggieMae
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by LittleMaggieMae »

How about Option C) 50/50?

$2900 towards Option A) and $2900 Option B).
I rather like this idea. By paying some of the mortgage down - while building up some "savings/investments" It would compensate for NOT knowing the answers to the questions below. (so that say in 2 or 3 years your world changes and you have to choose a course of action you didn't forsee now you have some flexibility. )

Why did you choose a 7/1 arm instead of a 30 year fixed? Is it because you expect to sell the house in the near future (some time in the next 7 years)? or did you take it expressly because it had the lowest interest rate (and costs)? It seems like a 30 or 15 year fixed mortgage would have been a better long term choice.

Where do you see your income going over the next 7 years? (up or down because a parent will stay home with the kids (who perhaps are still sparkles in you and your spouse's eyes at this time). )

Do you think Financial Independence is or soon will be one of your goals?
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

KlangFool wrote: Sun Apr 11, 2021 7:11 pm OP,

1) You are not conservative. You have a 900K house and 450K investment outside the house. You are "house poor" asset wise. What if the house crash 50% and do not recover for 10 years, then, what would you do?

2) It is not safe to put more money into the house. Hence, why do you think it is safe and make sense to pay off the mortgage in 7 years? You are "market timing" that the house will worth 900K or more in 7 years. And, that is 50% or more your net worth.

3) I vote for option (D).

A) Refinance to 30 years mortgage. Then, you do not need to "market time" that the house will not crash and you need to sell at the wrong time. This is a 900K house and 50% of your net worth. It is a huge RISK.

B) Invest as per your asset allocation and allocate 100% stock into your taxable account.

4) Do not keep most of your eggs in the "house" basket. Housing market has a very long cycle. And, you are taking a huge RISK on a single 900K house.

KlangFool
1) We have a 900k house and a net worth around 900k. If the house crashed 50% and did not recover for 10 years, it wouldn't matter to me. One thing that's maybe hidden in the background information I gave is that until 2019 my wife has been going through medical school and residency, so it's only recently that her income went from negative 30k (as a student) to positive 50k (as a resident) to positive 250k (as an attending). I know the 530k we have in retirement assets might not be too impressive given our age, but we're on something of a different glidepath then we were a few years ago, and we're saving 50% of our money each year.

2) Putting more money into the house seems safe from the standpoint of it being a guaranteed 2.125 percent return on the money. I understand that it's not safe as a hedge against inflation, or whatever. Maybe I meant to say that paying down the house is more certain, and to me that means less risky -- there's less volatility to the guaranteed rate of return. We plan on living in this house at least until our kids are grown and gone, and maybe longer. We really like the house. So I don't think I'm timing that the house will be worth more or less or anything in 7 years, just that we'd feel better living in a paid for house. The house minus the mortgage is currently about 29% of our net worth. I think it will tend to trend lower as we sock away more into retirement investments each year, but if it keeps appreciating faster than we can save in our other accounts, I'm not going to complain.

3) I just finished refinancing last week, I'm not gonna refinance again. But, I've read your point. If the market crashed, we wouldn't sell the house. If the market boomed, we wouldn't sell the house. We're not selling the house unless we want to move to Hawaii or something after the kids are grown and gone. And even then, I like the house. I don't believe there's a reasonable scenario where we'll be forced to sell the house. I guess I'll concede if it turns out my wife is a notorious serial killer who has been murdering a bunch of her patients and can no longer practice medicine, maybe we need to downsize the homestead. As it is, the PITI on the house is 14% of our take home pay. We don't feel house poor.

4) Not to harp on it, but again, we didn't buy the house because it's our ticket to a golden retirement. We bought it because we really like the house in a neighborhood we really like in a city we really like. If its value was cut in half tomorrow, that'd be fine with me.



We're putting $68k a year in tax advantaged accounts for retirement. We have another $70k a year that we don't need for anything else -- so we're planning on paying off our house. It feels like a sustainable thing, I'm just trying to figure out the smartest use for that $70k a year, I guess. I think we'll be pretty happy 7 years from now if we still this fabulous income and don't have any payments to anyone, so that's the objective.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
Topic Author
Scooter K
Posts: 41
Joined: Thu Jun 08, 2017 1:38 pm

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

LittleMaggieMae wrote: Sun Apr 11, 2021 7:24 pm
How about Option C) 50/50?

$2900 towards Option A) and $2900 Option B).
I rather like this idea. By paying some of the mortgage down - while building up some "savings/investments" It would compensate for NOT knowing the answers to the questions below. (so that say in 2 or 3 years your world changes and you have to choose a course of action you didn't forsee now you have some flexibility. )

Why did you choose a 7/1 arm instead of a 30 year fixed? Is it because you expect to sell the house in the near future (some time in the next 7 years)? or did you take it expressly because it had the lowest interest rate (and costs)? It seems like a 30 or 15 year fixed mortgage would have been a better long term choice.

Where do you see your income going over the next 7 years? (up or down because a parent will stay home with the kids (who perhaps are still sparkles in you and your spouse's eyes at this time). )

Do you think Financial Independence is or soon will be one of your goals?
We had a choice between a 2.5% 15yr fixed or a 2.125% 7/1ARM. Since we were already just about on track to pay it off in 7 years, I figured the extra 0.4% saves us a couple thousand a year. It was definitely a debate -- why put a cliff in front of the road 7 years from now if you don't have to? Well, I thought the cliff was worth the money -- it's like $2400 saved this year alone. And, if we don't quite hit the target the balance on the loan will be relatively small when the rate change happens. Say it's 7% on 50k, that's still worth having the past 7 years at the lower rate (and will be all the bigger kick in the butt we need to finish it off). We don't expect to sell.

Expecting income to go up as my wife becomes a full partner this year and has been phasing upwards into her group. But, probably pretty steady after that. I'm a big fan of her working less and being happier, so while she could crank up the hours to go for 350k or 400k, it just doesn't seem that fun or sustainable. The kids are more a thorn in my side then a twinkle in my eye at this point -- i've been a stay at home dad since she finished residency and it's been well, mostly great. Kinda tiring. That's another thread. I could go back to work if we needed me to, which is another contingency plan.

Financial Independence is a goal. We're pretty happy living off of 70k a year, so if we had a paid for house we're probably looking at something like $2m in the bank to be able to walk away from work, but who knows?


I'll count you as another vote for Option C, thanks for your feedback. I've read a few other posts where I think Taylor Larimore has said "if the decision is close, it probably doesn't matter much so just go 50/50 and move on." Sorry if I don't have the quote quite right, but that's another vote for Option C.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by KlangFool »

Scooter K wrote: Sun Apr 11, 2021 7:35 pm
KlangFool wrote: Sun Apr 11, 2021 7:11 pm OP,

1) You are not conservative. You have a 900K house and 450K investment outside the house. You are "house poor" asset wise. What if the house crash 50% and do not recover for 10 years, then, what would you do?

2) It is not safe to put more money into the house. Hence, why do you think it is safe and make sense to pay off the mortgage in 7 years? You are "market timing" that the house will worth 900K or more in 7 years. And, that is 50% or more your net worth.

3) I vote for option (D).

A) Refinance to 30 years mortgage. Then, you do not need to "market time" that the house will not crash and you need to sell at the wrong time. This is a 900K house and 50% of your net worth. It is a huge RISK.

B) Invest as per your asset allocation and allocate 100% stock into your taxable account.

4) Do not keep most of your eggs in the "house" basket. Housing market has a very long cycle. And, you are taking a huge RISK on a single 900K house.

KlangFool
1) We have a 900k house and a net worth around 900k. If the house crashed 50% and did not recover for 10 years, it wouldn't matter to me. One thing that's maybe hidden in the background information I gave is that until 2019 my wife has been going through medical school and residency, so it's only recently that her income went from negative 30k (as a student) to positive 50k (as a resident) to positive 250k (as an attending). I know the 530k we have in retirement assets might not be too impressive given our age, but we're on something of a different glidepath then we were a few years ago, and we're saving 50% of our money each year.

2) Putting more money into the house seems safe from the standpoint of it being a guaranteed 2.125 percent return on the money. I understand that it's not safe as a hedge against inflation, or whatever. Maybe I meant to say that paying down the house is more certain, and to me that means less risky -- there's less volatility to the guaranteed rate of return. We plan on living in this house at least until our kids are grown and gone, and maybe longer. We really like the house. So I don't think I'm timing that the house will be worth more or less or anything in 7 years, just that we'd feel better living in a paid for house. The house minus the mortgage is currently about 29% of our net worth. I think it will tend to trend lower as we sock away more into retirement investments each year, but if it keeps appreciating faster than we can save in our other accounts, I'm not going to complain.

3) I just finished refinancing last week, I'm not gonna refinance again. But, I've read your point. If the market crashed, we wouldn't sell the house. If the market boomed, we wouldn't sell the house. We're not selling the house unless we want to move to Hawaii or something after the kids are grown and gone. And even then, I like the house. I don't believe there's a reasonable scenario where we'll be forced to sell the house. I guess I'll concede if it turns out my wife is a notorious serial killer who has been murdering a bunch of her patients and can no longer practice medicine, maybe we need to downsize the homestead. As it is, the PITI on the house is 14% of our take home pay. We don't feel house poor.

4) Not to harp on it, but again, we didn't buy the house because it's our ticket to a golden retirement. We bought it because we really like the house in a neighborhood we really like in a city we really like. If its value was cut in half tomorrow, that'd be fine with me.



We're putting $68k a year in tax advantaged accounts for retirement. We have another $70k a year that we don't need for anything else -- so we're planning on paying off our house. It feels like a sustainable thing, I'm just trying to figure out the smartest use for that $70k a year, I guess. I think we'll be pretty happy 7 years from now if we still this fabulous income and don't have any payments to anyone, so that's the objective.
Scooter K,

1) Out of your 900K net worth, 300K is home equity. Hence, you have a 900K house and 600K outside the house.

2) Not if your wife lose her job and forced to move away from this area to find a new job.

3) What if your wife lose her job or the employer is out of business? And, you are forced to move and the house is underwater? You would be paying mortgage and rent at a new location at the same time. At that point, liquidity matters. But, most of your money is tied into the illiquid house.

4) Only if you are not forced to move.

<<We're putting $68k a year in tax advantaged accounts for retirement. We have another $70k a year that we don't need for anything else -- so we're planning on paying off our house. It feels like a sustainable thing, I'm just trying to figure out the smartest use for that $70k a year, I guess. I think we'll be pretty happy 7 years from now if we still this fabulous income and don't have any payments to anyone, so that's the objective.>>

Only it is smooth sailing over the next 7 years, What if it is not? Not paying off the mortgage and maintain your liquidity is safer. At least until your portfolio outside the house is substantially bigger. At this moment, you have a 900K house and 600K outside the house.

How long can you survive in the worst case? Unemployed, house and stock market drops 50%? Before you lose everything.

KlangFool
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Topic Author
Scooter K
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Joined: Thu Jun 08, 2017 1:38 pm

Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

KlangFool wrote: Sun Apr 11, 2021 8:08 pm
Scooter K,

1) Out of your 900K net worth, 300K is home equity. Hence, you have a 900K house and 600K outside the house.

2) Not if your wife lose her job and forced to move away from this area to find a new job.

3) What if your wife lose her job or the employer is out of business? And, you are forced to move and the house is underwater? You would be paying mortgage and rent at a new location at the same time. At that point, liquidity matters. But, most of your money is tied into the illiquid house.

4) Only if you are not forced to move.

<<We're putting $68k a year in tax advantaged accounts for retirement. We have another $70k a year that we don't need for anything else -- so we're planning on paying off our house. It feels like a sustainable thing, I'm just trying to figure out the smartest use for that $70k a year, I guess. I think we'll be pretty happy 7 years from now if we still this fabulous income and don't have any payments to anyone, so that's the objective.>>

Only it is smooth sailing over the next 7 years, What if it is not? Not paying off the mortgage and maintain your liquidity is safer. At least until your portfolio outside the house is substantially bigger. At this moment, you have a 900K house and 600K outside the house.

How long can you survive in the worst case? Unemployed, house and stock market drops 50%? Before you lose everything.

KlangFool
Hi KlangFool

1) I think that's pretty close to correct on the numbers.

2) That's true. Emergency Medicine seems to be in pretty universal demand, and we do have long term disability insurance in place, but if something happened where she couldn't practice medicine, we'd need a different plan. I'm not sure it's relevant to the question of whether to pay off the house directly and quickly, or to invest the money for a payoff down the road. Unless you're still advocating a refinance to a 30 year mortgage -- but that's probably gonna cost us $7k and puts us $7k worse off (plus interest on the higher APR) in case she loses her job and we relocate, etc. But yes, we may have to move if things go as badly as one could imagine.

3) If her group goes out of business or doesn't renew contract with one of the local hospital systems (in three years), she could find herself out of a job. Our emergency fund can easily cover six months of expenses, and probably could stretch to 9 months without too much strain. I'm not sure what scenario we're underwater on the house though. If she's out of work next month and property prices go down 30% this month, we're about break even on the house. If she hangs in there for another year, and we've put another 100k towards the house, then it needs to go down in value 40% for us to be close to underwater. If instead the unemployment happens in 2023, we've done yet another 100k towards the house and then it needs to go down in value like 55%? I mean, the best chance of us being underwater on the house is her losing her job next month and the house going down 35%. Seems a lot more likely we should worry about a divorce then this housing crash + job loss. She did just get offered the partnership, so if she was going to be let go for performance, or some such, it seems like they would do that just before making her partner rather than just after. But, still, I mean some huge malpractice lawsuit or something like that could easily be a big wrench in the plans. Still though, is that a reason to not pay off the house we live in?

4) If it's value was cut in half tomorrow and we were forced to move tomorrow also. Well, did any other house values get cut in half tomorrow, or was it just ours? Because we could trade our half price house in our city for a half price house in a different city, using our emergency fund to float the six months or whatever that takes to do. Seems like it would be fine. I do like our house though. Someone would be getting a really good deal on a house.


"How long can you survive in the worst case? Unemployed, house and stock market drops 50%? Before you lose everything."

The worst case scenario is we're both unemployed and unable to find work, the house and stock market drops 50%. How long could we survive in that case? I tend to think there'd be at least something like hustling delivering pizza and making 2k a month. To keep the house, we probably need 4k a month, so burning 2k a month in that scenario. 45k emergency fund = 22 months. But then I could withdraw Roth contributions without penalty. I don't know, I think we could run the string out for 7 years or something like that? I can't really fathom that neither of us is able to work, but both still alive and able bodied. Stock market down would be great, if we could get some income it would be time to load up!


Okay, all that's to say, my original question is if there's anything else I should consider when deciding to pay off the mortgage directly, or to put money into a taxable investment account for more growth during our timeframe. It sounds like your vote would be for more liquidity.


Thanks for giving me some downside scenarios to chew on. I tend to be an optimist, but always good to have contingencies.

Scooter
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
babystep
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by babystep »

Scooter K wrote: Sun Apr 11, 2021 7:35 pm
KlangFool wrote: Sun Apr 11, 2021 7:11 pm OP,

1) You are not conservative. You have a 900K house and 450K investment outside the house. You are "house poor" asset wise. What if the house crash 50% and do not recover for 10 years, then, what would you do?

2) It is not safe to put more money into the house. Hence, why do you think it is safe and make sense to pay off the mortgage in 7 years? You are "market timing" that the house will worth 900K or more in 7 years. And, that is 50% or more your net worth.

3) I vote for option (D).

A) Refinance to 30 years mortgage. Then, you do not need to "market time" that the house will not crash and you need to sell at the wrong time. This is a 900K house and 50% of your net worth. It is a huge RISK.

B) Invest as per your asset allocation and allocate 100% stock into your taxable account.

4) Do not keep most of your eggs in the "house" basket. Housing market has a very long cycle. And, you are taking a huge RISK on a single 900K house.

KlangFool
1) We have a 900k house and a net worth around 900k. If the house crashed 50% and did not recover for 10 years, it wouldn't matter to me. One thing that's maybe hidden in the background information I gave is that until 2019 my wife has been going through medical school and residency, so it's only recently that her income went from negative 30k (as a student) to positive 50k (as a resident) to positive 250k (as an attending). I know the 530k we have in retirement assets might not be too impressive given our age, but we're on something of a different glidepath then we were a few years ago, and we're saving 50% of our money each year.

2) Putting more money into the house seems safe from the standpoint of it being a guaranteed 2.125 percent return on the money. I understand that it's not safe as a hedge against inflation, or whatever. Maybe I meant to say that paying down the house is more certain, and to me that means less risky -- there's less volatility to the guaranteed rate of return. We plan on living in this house at least until our kids are grown and gone, and maybe longer. We really like the house. So I don't think I'm timing that the house will be worth more or less or anything in 7 years, just that we'd feel better living in a paid for house. The house minus the mortgage is currently about 29% of our net worth. I think it will tend to trend lower as we sock away more into retirement investments each year, but if it keeps appreciating faster than we can save in our other accounts, I'm not going to complain.

3) I just finished refinancing last week, I'm not gonna refinance again. But, I've read your point. If the market crashed, we wouldn't sell the house. If the market boomed, we wouldn't sell the house. We're not selling the house unless we want to move to Hawaii or something after the kids are grown and gone. And even then, I like the house. I don't believe there's a reasonable scenario where we'll be forced to sell the house. I guess I'll concede if it turns out my wife is a notorious serial killer who has been murdering a bunch of her patients and can no longer practice medicine, maybe we need to downsize the homestead. As it is, the PITI on the house is 14% of our take home pay. We don't feel house poor.

4) Not to harp on it, but again, we didn't buy the house because it's our ticket to a golden retirement. We bought it because we really like the house in a neighborhood we really like in a city we really like. If its value was cut in half tomorrow, that'd be fine with me.



We're putting $68k a year in tax advantaged accounts for retirement. We have another $70k a year that we don't need for anything else -- so we're planning on paying off our house. It feels like a sustainable thing, I'm just trying to figure out the smartest use for that $70k a year, I guess. I think we'll be pretty happy 7 years from now if we still this fabulous income and don't have any payments to anyone, so that's the objective.
Have you considered a side hustle, maybe screen writer for movies or writing mystery novels? :wink:
solarcub
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by solarcub »

I would go with option C. You earn a small guaranteed returns on half the money, and the rest goes into the market. If the next 7 years are average, you come out ahead, but if stocks are down the next 7 years you can handle it, and will have a significantly smaller mortgage by the time the rate adjusts.
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

babystep wrote: Sun Apr 11, 2021 9:17 pm Have you considered a side hustle, maybe screen writer for movies or writing mystery novels? :wink:
:sharebeer
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
LittleMaggieMae
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by LittleMaggieMae »

Scooter K wrote: Sun Apr 11, 2021 7:45 pm
LittleMaggieMae wrote: Sun Apr 11, 2021 7:24 pm
How about Option C) 50/50?

$2900 towards Option A) and $2900 Option B).
I rather like this idea. By paying some of the mortgage down - while building up some "savings/investments" It would compensate for NOT knowing the answers to the questions below. (so that say in 2 or 3 years your world changes and you have to choose a course of action you didn't forsee now you have some flexibility. )

Why did you choose a 7/1 arm instead of a 30 year fixed? Is it because you expect to sell the house in the near future (some time in the next 7 years)? or did you take it expressly because it had the lowest interest rate (and costs)? It seems like a 30 or 15 year fixed mortgage would have been a better long term choice.

Where do you see your income going over the next 7 years? (up or down because a parent will stay home with the kids (who perhaps are still sparkles in you and your spouse's eyes at this time). )

Do you think Financial Independence is or soon will be one of your goals?
We had a choice between a 2.5% 15yr fixed or a 2.125% 7/1ARM. Since we were already just about on track to pay it off in 7 years, I figured the extra 0.4% saves us a couple thousand a year. It was definitely a debate -- why put a cliff in front of the road 7 years from now if you don't have to? Well, I thought the cliff was worth the money -- it's like $2400 saved this year alone. And, if we don't quite hit the target the balance on the loan will be relatively small when the rate change happens. Say it's 7% on 50k, that's still worth having the past 7 years at the lower rate (and will be all the bigger kick in the butt we need to finish it off). We don't expect to sell.

Expecting income to go up as my wife becomes a full partner this year and has been phasing upwards into her group. But, probably pretty steady after that. I'm a big fan of her working less and being happier, so while she could crank up the hours to go for 350k or 400k, it just doesn't seem that fun or sustainable. The kids are more a thorn in my side then a twinkle in my eye at this point -- i've been a stay at home dad since she finished residency and it's been well, mostly great. Kinda tiring. That's another thread. I could go back to work if we needed me to, which is another contingency plan.

Financial Independence is a goal. We're pretty happy living off of 70k a year, so if we had a paid for house we're probably looking at something like $2m in the bank to be able to walk away from work, but who knows?


I'll count you as another vote for Option C, thanks for your feedback. I've read a few other posts where I think Taylor Larimore has said "if the decision is close, it probably doesn't matter much so just go 50/50 and move on." Sorry if I don't have the quote quite right, but that's another vote for Option C.
I find it abit odd that you are second guessing all your decisions up to this point. If you charted out your 7 year plan (and beyond) when you took the 7/1 mortgage - what changed? It sounds like you are thinking maybe your well thought out plan isn't such a good idea after all. :)

(FWIW: I still like a 50/50 plan... as it buys you the most flexibility with future income - which is one of the reasons to borrow at low rates. If you do make a "sea change" on how you will pay off the mortgage, I would suggest coming up with some ideas for how you will handle any increases in income or "windfall" bonuses. Will you increase how much monthly you putting towards the mortgage? or increase your retirement $$, savings/investments? You still might get to a paid off or nearly paid off mortgage in 7 years and have a Pile of Money, too. :)
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

LittleMaggieMae wrote: Sun Apr 11, 2021 9:42 pm I find it abit odd that you are second guessing all your decisions up to this point. If you charted out your 7 year plan (and beyond) when you took the 7/1 mortgage - what changed? It sounds like you are thinking maybe your well thought out plan isn't such a good idea after all. :)

(FWIW: I still like a 50/50 plan... as it buys you the most flexibility with future income - which is one of the reasons to borrow at low rates. If you do make a "sea change" on how you will pay off the mortgage, I would suggest coming up with some ideas for how you will handle any increases in income or "windfall" bonuses. Will you increase how much monthly you putting towards the mortgage? or increase your retirement $$, savings/investments? You still might get to a paid off or nearly paid off mortgage in 7 years. :)
My wife finds it a bit odd, too. The plan was the 7/1ARM, and pay this thing off in 7 years. Chunk Chunk Chunk towards the mortgage each month.

I'm about to send in the first Chunk on the new mortgage, and man, just got to thinking that this thing is darn near the inflation rate and doesn't it seem low risk to just invest and bank the spread, and am I leaving 200k on the table in the next seven years for a couple hours of work, and then... blah blah blah --> bogleheads.


I still think paying off the mortgage quickly is a great plan, so that's what I want to do. But what's the best way to do that? And is there anything else I should consider?

Future windfall is probably going to be split between the mortgage and enjoyment -- travel, dining out more.


I think the 50/50 plan is a pretty good compromise. It reminds me of our asset allocation. We went 70/30 on stocks/bonds because she wanted 50/50 and I wanted 90/10. So, 70/30 we're both equally unhappy. 50/50 sounds like I'll be pretty unhappy if the market stinks and pretty unhappy if the market soars. Good compromise.

Thank you, and thanks to the other posters who helped with their insights on this question. I'm still open to more points of view, but I'm gonna pitch the 50/50 to my wife next time we sit down for it.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
ScaledWheel
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by ScaledWheel »

I can tell you what I do, which is a bit of a mix of the approaches, but adds in some non-Bogleheadian complications.

I am "chunking" a similar number to you, around $6k/month into a mix of taxable and paying down mortgage principal. My flow for figuring out how to allocate that $6k is:

1. Calculate the 50-day exponentially-weighted moving average of the SP500, take the slope of this line.
2a. If this value is greater than 0 on the day I am putting in my chunk, then 60% goes into taxable, 40% goes towards principal.
2b. If this values is <=0 on this day, then it follows goes 100% into taxable.

The reasoning follows a very basic "momentum" metric. So yes, it is market timing and not Bogleheadian. I am actually already paying extra on my mortgage so even in situation (2b) I am speeding up debt paydown. But this simple metric helps me minimize loss regret (in my own mind) by giving me a simple rule to follow for when the market is experiencing a pull back.

Below is a chart that shows how this metric looked over the last few years. In the shaded region, I am 60/40, in the white region I'm contributing 100% into taxable.

Image
harikaried
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by harikaried »

Scooter K wrote: Sun Apr 11, 2021 9:51 pmWe went 70/30 on stocks/bonds because she wanted 50/50 and I wanted 90/10. So, 70/30 we're both equally unhappy.
So with $600k invested, that's roughly $420k in stocks and $180k in bonds, with say 1.5% yield earning $3k while your $640k mortgage charges $14k interest. If you paid down the mortgage by $130k using bonds (treating the dollars charging 2.125% interest equally to the lower yielding bonds), you would end up with $420k stocks and $50k bonds for a 90/10 gross asset allocation. Although if you want to look at the net asset allocation, you could look at it as $420k stocks and -$460k bonds independent of how much you pay down the mortgage with bonds, so this debt/leverage puts you more aggressive than 70/30 which should be fine as your house avoids needing to pay rent.
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

harikaried wrote: Sun Apr 11, 2021 10:52 pm
Scooter K wrote: Sun Apr 11, 2021 9:51 pmWe went 70/30 on stocks/bonds because she wanted 50/50 and I wanted 90/10. So, 70/30 we're both equally unhappy.
So with $600k invested, that's roughly $420k in stocks and $180k in bonds, with say 1.5% yield earning $3k while your $640k mortgage charges $14k interest. If you paid down the mortgage by $130k using bonds (treating the dollars charging 2.125% interest equally to the lower yielding bonds), you would end up with $420k stocks and $50k bonds for a 90/10 gross asset allocation. Although if you want to look at the net asset allocation, you could look at it as $420k stocks and -$460k bonds independent of how much you pay down the mortgage with bonds, so this debt/leverage puts you more aggressive than 70/30 which should be fine as your house avoids needing to pay rent.
Hi Harikaried,

Yeah the 640k debt on the house is a negative bond, so we're not really on our target 70/30 allocation at the moment, not even close. I don't realistically have the option to pay down the mortgage with our bond funds, because all of our investments are in Roth and 401k instruments. I guess mentally I think of our income something like a bond, so transferring half that paycheck to the mortgage feels like canceling a negative bond with a positive bond. Honestly, I don't know enough about how to properly do it, but we just decided we have a retirement asset allocation we're going to stick to, and if we're taking more risk now with leverage on our home, it's offset by being young and healthy and able to work more. As we get older and less able to work, the leverage on the house is going away -- it feels like that's just about good enough but I truly don't know what the proper answer is.

I also think the reasoning doesn't change the decision to pay down the house soon, though maybe it would make me think about taking less risk in our retirement accounts to balance the riskier leveraged home asset. It's a good point, something to think about. Thanks! If you have more to say on the topic, I'm interested.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
Goal33
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Goal33 »

Refinance at the same rate for a 15 year fixed. It’ll pay off right around your retirement target date.
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

Goal33 wrote: Sun Apr 11, 2021 11:29 pm Refinance at the same rate for a 15 year fixed. It’ll pay off right around your retirement target date.
I've already addressed this suggestion.

Having just completed a refinance last week, I'm not going to pay closing costs again for a higher interest rate loan that will take longer to pay off.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
MiddleOfTheRoad
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by MiddleOfTheRoad »

Option B. Invest the difference. In 7 yrs your loan is not going to require a lump sum. So if it happens that year 7 is a down year you can drag it out a little with not too much more interest payment (since your balance will be smaller). Or start a glide path to more conservative starting year 5 if you are far ahead at that point.
lakpr
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by lakpr »

Scooter K wrote: Sun Apr 11, 2021 11:24 pm Hi Harikaried,

Yeah the 640k debt on the house is a negative bond, so we're not really on our target 70/30 allocation at the moment, not even close. I don't realistically have the option to pay down the mortgage with our bond funds, because all of our investments are in Roth and 401k instruments. I guess mentally I think of our income something like a bond, so transferring half that paycheck to the mortgage feels like canceling a negative bond with a positive bond. Honestly, I don't know enough about how to properly do it, but we just decided we have a retirement asset allocation we're going to stick to, and if we're taking more risk now with leverage on our home, it's offset by being young and healthy and able to work more. As we get older and less able to work, the leverage on the house is going away -- it feels like that's just about good enough but I truly don't know what the proper answer is.

I also think the reasoning doesn't change the decision to pay down the house soon, though maybe it would make me think about taking less risk in our retirement accounts to balance the riskier leveraged home asset. It's a good point, something to think about. Thanks! If you have more to say on the topic, I'm interested.
I am not sure why you think it is an issue to exchange bonds to stocks inside the 401k?

70:30 portfolio means approximately $2 invested in stocks for every dollar invested in bonds, right?

You also said between your taxable investments ( yet to be made) and your tax deferred you were going to save approximately $120k per year, right?

You have $5800 * 12 = $70k approximately which you can consider paying down the mortgage, right?

As you do so, exchange $140k from bonds to stocks in the 401k (same 2:1 ratio). Done, simple.

Once all your 401k and Roth IRAs are saturated with 100% equities, you can still invest $30k per year to mortgage and remainder $40k in taxable account into equities, which does sound an awful lot like 50:50 split between investing in prepaying mortgage and investing in equities suggested up thread. But this is a course of action to take AFTER you exhausted/exchanged all bonds in your tax-deferred / tax advantaged accounts. With $180k in bonds currently, that should last you an year and half before you need to go 50:50
gideon trumpet
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by gideon trumpet »

Scooter K wrote: Sun Apr 11, 2021 7:35 pm I guess I'll concede if it turns out my wife is a notorious serial killer who has been murdering a bunch of her patients and can no longer practice medicine, maybe we need to downsize the homestead.
Nah, nothing a well-crafted trust and life insurance policy can't handle . . . .
mbasherp
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by mbasherp »

It’s important that you don’t absolutely have to pay this off in 7 years. Even if it’s not paid off:

-Your rate adjustment may not necessarily be what you expect
-You might be able to refinance at attractive rates
-Other unexpected scenarios may arise

Whether you put extra in along the way or invest to build a lump sum for later, you’ll have the option at that point, and you’ll have the ability to be working with a smaller principal balance. Let’s say you invested it all and it hasn’t worked in your favor... you don’t HAVE to pull your investments and pay off the mortgage.

I personally am in the invest (at the very least until taxable exceeds mortgage balance) camp. But 50/50 works too. Even paying it all off in 7, if that’s the path that works psychologically. But the essence of my thought is that there’s no use assuming what conditions will be 7 years from now.
BrooklynInvest
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by BrooklynInvest »

babystep wrote: Sun Apr 11, 2021 6:11 pm How about Option C) 50/50?
Option C. First, you're starting your early retirement fund, a good thing given your timeline. Second, worst case is your rate goes up and you're paying more on what will be a pretty small balance by that point so it won't cost you much, y'know relatively speaking.

How about Option C 2.0 - Option C until you get within a couple of years of the mortgage reset. At that point if it looks like any rate increase is gonna cost you, pay down more?
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

lakpr wrote: Mon Apr 12, 2021 12:13 am I am not sure why you think it is an issue to exchange bonds to stocks inside the 401k?

70:30 portfolio means approximately $2 invested in stocks for every dollar invested in bonds, right?

You also said between your taxable investments ( yet to be made) and your tax deferred you were going to save approximately $120k per year, right?

You have $5800 * 12 = $70k approximately which you can consider paying down the mortgage, right?

As you do so, exchange $140k from bonds to stocks in the 401k (same 2:1 ratio). Done, simple.

Once all your 401k and Roth IRAs are saturated with 100% equities, you can still invest $30k per year to mortgage and remainder $40k in taxable account into equities, which does sound an awful lot like 50:50 split between investing in prepaying mortgage and investing in equities suggested up thread. But this is a course of action to take AFTER you exhausted/exchanged all bonds in your tax-deferred / tax advantaged accounts. With $180k in bonds currently, that should last you an year and half before you need to go 50:50

I think the suggestion was that I could use some or all of my current bond holdings (~180k) to pay down the negative bond (mortgage 640k). If my holdings were outside of retirement accounts, I could pay the mortgage down to 460k with the 180k in bonds. However, that's not feasible because of the penalties such a move would incur.

I'm trying to follow your reasoning, but I confess I don't understand why I would exchange bonds for stocks in our retirement accounts as we pay down the mortgage.

I'll explain my point of view and you can tell me what I misunderstand.


My desired asset allocation investing towards retirement is 70/30. Currently, we have about 380k in stocks, 160k in bonds, which is right on that target allocation. All of that is in retirement accounts.

But we owe 640k on our house, which charges 2.125% interest. That feels to me very much like a negative bond. So don't we actually have 380k in stock and -480k in bonds? That's not 70/30, that's however you express borrowing money at a fixed rate to invest more money in stocks, isn't it?

So as we pay down the house, that -480k will turn into -380k, -280k, etc, until eventually our bond holdings are positive again. Maybe that's what you're saying, as you pay down the house you can convert bonds to stocks to maintain the same exposure?

My thought has been to keep retirement investments and housing separate -- our retirement is at 70/30 and our housing is something we consume each month and we cashflow with our pay. So I haven't been framing the mortgage as part of the investment portfolio even though, I mean, they're all directly related to one another.

I would really enjoy more explanation on your idea, thank you,
Scooter
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
Topic Author
Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

mbasherp wrote: Mon Apr 12, 2021 7:24 am It’s important that you don’t absolutely have to pay this off in 7 years. Even if it’s not paid off:

-Your rate adjustment may not necessarily be what you expect
-You might be able to refinance at attractive rates
-Other unexpected scenarios may arise

Whether you put extra in along the way or invest to build a lump sum for later, you’ll have the option at that point, and you’ll have the ability to be working with a smaller principal balance. Let’s say you invested it all and it hasn’t worked in your favor... you don’t HAVE to pull your investments and pay off the mortgage.

I personally am in the invest (at the very least until taxable exceeds mortgage balance) camp. But 50/50 works too. Even paying it all off in 7, if that’s the path that works psychologically. But the essence of my thought is that there’s no use assuming what conditions will be 7 years from now.
I agree. If Option B doesn't go that well, we're not destitute, we're just out $50k or $100k or 1 year extra of work. And Option B is a bit more flexible for unexpected scenarios. There's no hard deadline at seven years, other than that which we choose to impose on ourselves. Thanks for your input!
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
lakpr
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by lakpr »

Scooter K wrote: Mon Apr 12, 2021 9:25 am So as we pay down the house, that -480k will turn into -380k, -280k, etc, until eventually our bond holdings are positive again. Maybe that's what you're saying, as you pay down the house you can convert bonds to stocks to maintain the same exposure?
Correct.
Scooter K wrote: Mon Apr 12, 2021 9:25 am My thought has been to keep retirement investments and housing separate -- our retirement is at 70/30 and our housing is something we consume each month and we cashflow with our pay. So I haven't been framing the mortgage as part of the investment portfolio even though, I mean, they're all directly related to one another.
Yes, this is precisely where I am differing from your view point. View your entire portfolio as one, do not look at mortgage as its mini portfolio, retirement as its own mini portfolio, taxable account as its own mini portfolio, and try to achieve 70:30 in each of these mini portfolios. That is inefficient. Instead look at your entire portfolio as one, and direct your current and future dollars to their most tax-efficient location.

If you have $1000 in bonds in your 401k, those bonds are earning 1.3% (yield on the total bond market fund right now). Meanwhile you are paying 2.125% on a negative bond. There is nearly 0.9% interest rate arbitrage to be had here. Assuming you have $1000 available now that you cannot invest in any tax-advantaged account (401k, IRA, HSA all maxed out), *AND* you have at least $2000 available in bonds within the 401k ...

70:30 allocation ~= 2:1 stocks to bonds
If you invest $1 in bonds, move $2 to stocks

You can either:
- Invest $700 in equities in taxable
- Invest $300 in bonds in taxable (in your tax bracket perhaps muni bonds are more preferable)

OR

- Invest $1000 in equities in taxable
- Move $300 from equities to bonds within your 401k (all your bonds in your portfolio reside in your 401k)

OR

- Use $1000 you have on hand to prepay the mortgage (you are offsetting a negative bond)
- Move $2000 from bonds to equities within your 401k (your positive bonds are still in your 401k, taxable account is nil, you haven't incurred any tax cost).

ALL OF THEM HAVE EXACT 70:30 TARGET ALLOCATION

Your current portfolio is what it is (100 : -125 approximately). You cannot change it instantaneously to 70:30 portfolio, as you said, not without incurring significant tax costs and penalties. Your FUTURE DOLLARS however, can be made use of to move towards your target allocation slowly.
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Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

lakpr wrote: Mon Apr 12, 2021 11:06 am
- Use $1000 you have on hand to prepay the mortgage (you are offsetting a negative bond)
- Move $2000 from bonds to equities within your 401k (your positive bonds are still in your 401k, taxable account is nil, you haven't incurred any tax cost).

ALL OF THEM HAVE EXACT 70:30 TARGET ALLOCATION

Your current portfolio is what it is (100 : -125 approximately). You cannot change it instantaneously to 70:30 portfolio, as you said, not without incurring significant tax costs and penalties. Your FUTURE DOLLARS however, can be made use of to move towards your target allocation slowly.

If my current portfolio is 100:-125, as you say, and my desired portfolio is 70:30, then isn't the rational move to convert all stock holdings in my retirement accounts to bonds, such that my overall picture would be $0 stocks, $540k bonds, -$640k mortgage. And after paying off 100k of the mortgage, I'd effectively be at 0/0 (540k in retirement bonds, 540k in mortgage debt). Then when I pay $1k on the mortgage I could convert $700 of bonds to stock. So it would look like 539.3 in bonds, .7 in stocks, -539 in mortgage debt. That's +$700 stocks, +$300 in bonds, 70/30 split is finally achieved.

This seems a bit insensible to me, though I'm not sure I can put a finger on why. It doesn't seem correct to have no stock exposure during the prime of our working lives with decades ahead of us. You've encouraged me to view our entire portfolio as one, but I think the component that is missing is our income, which comes from a secure job in a secure field -- people always need to go to the doctor.

So looking at the whole picture, I think I should consider:
Retirement Accounts: Currently 540k (380stocks/160bonds)
Taxable Accounts: Currently 0.
Mortgage Balance: Currently -640k
Monthly Income after living expenses: Currently around 5k. (this is about what we have extra after funding all retirement accounts, paying for living expenses, minimum on the mortgage, etc).

Though that 5k/month income isn't forever: If we're planning on working the next 13 years before retiring, what would you trade me in bond holdings right now for $5k/month income for 13 years (but then the faucet turns off)? Hmm, since the mortage/bond rates we're talking about are pretty close to inflation, 13 years of $5k/month comes out to $780k just by multiplying 5k*12months*13years. I think that works out -- if you draw 2% interest off of 780k and take the rest out of principal to get your $5k/month, the fund would be zeroed out in 13 years (I just assumed inflation would be about 2% to make the math easy).

So then the whole picture looks like 380k stocks, 300k bonds (160-640+780), a 56/44 allocation. And effectively that 780k in paychecks coming in will cancel out the -640k in mortgage debt we hold, so that a year from now when 60k additional has been paid off, allocation looks something like 380k stocks, 300k bonds (160-580+720). Though we're gonna keep funding retirement accounts and the required principal payments mean the mortgage would be better than 580. Probably a year from now we're more like 430k stocks, 330k bonds(180-570+720).


All of this to say, I think our income just about cancels out the mortgage, at least it falls within the bounds of uncertainty around future employment, future earnings, future retirement date. If in some sense we're at a 56/44 allocation right now (hey, tell me if I'm way off on that, I'm working through this), then Option B seems to fit within our allocation plan -- we could use more stock exposure and defer paying down the mortgage.

I'm sorry to have such a long-winded post, cheers to anyone who read so far, and thank you very much for the stimulating conversation, it's much appreciated and very helpful.

Scooter
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
harikaried
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by harikaried »

Scooter K wrote: Sun Apr 11, 2021 11:24 pmif we're taking more risk now with leverage on our home, it's offset by being young and healthy and able to work more. As we get older and less able to work, the leverage on the house is going away -- it feels like that's just about good enough but I truly don't know what the proper answer is.
I think one common reaction to realizing net negative bonds is leverage that one didn't intend to be so significantly aggressive, but as you point out, that can be totally fine with age and home covering rent. Part of it is seeing how it changes over time, so here's some numbers from now to the end of the 7th year starting with $540k maintained at 70/30 gross asset allocation assuming 7% stocks and 2% bonds growth with your regular $29k mortgage payment, $70k principal curtailment and $68k retirement savings:

Code: Select all

year 0: $378k stocks, $162k bonds, $640k mortgage = -$478k net bonds (100:-126)
year 1: $446k stocks, $191k bonds, $554k mortgage = -$363k net bonds (100: -81)
year 2: $519k stocks, $222k bonds, $467k mortgage = -$245k net bonds (100: -47)
year 3: $595k stocks, $255k bonds, $377k mortgage = -$123k net bonds (100: -21)
year 4: $675k stocks, $289k bonds, $286k mortgage =    $3k net bonds (100:   0)
year 5: $760k stocks, $326k bonds, $193k mortgage =  $133k net bonds ( 85:  15)
year 6: $849k stocks, $364k bonds,  $98k mortgage =  $266k net bonds ( 76:  24)
year 7: $943k stocks, $404k bonds,   $0k mortgage =  $404k net bonds ( 70:  30)
If that glide path to your 70:30 gross and net asset allocation seems fine, then paying down the mortgage could be your choice. Where choosing to make less principal curtailment means your net bonds is negative for longer than the 4 years of your Option A.
Reamus294
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Reamus294 »

I’m also a fan of Option C. We did something similar with smaller numbers but we are looking at a shorter time frame so it is just going to cash instead of into the market. If my time frame was 7 years, I would probably move to cash a year or two out if the market was still good. This is market timing in my eyes, but I’m ok with that. I also would build my parameters ahead of time to make it less emotional.
Good luck with it, it sounds like you are on the right path.
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Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

harikaried wrote: Mon Apr 12, 2021 12:35 pm
Scooter K wrote: Sun Apr 11, 2021 11:24 pmif we're taking more risk now with leverage on our home, it's offset by being young and healthy and able to work more. As we get older and less able to work, the leverage on the house is going away -- it feels like that's just about good enough but I truly don't know what the proper answer is.
I think one common reaction to realizing net negative bonds is leverage that one didn't intend to be so significantly aggressive, but as you point out, that can be totally fine with age and home covering rent. Part of it is seeing how it changes over time, so here's some numbers from now to the end of the 7th year starting with $540k maintained at 70/30 gross asset allocation assuming 7% stocks and 2% bonds growth with your regular $29k mortgage payment, $70k principal curtailment and $68k retirement savings:

Code: Select all

year 0: $378k stocks, $162k bonds, $640k mortgage = -$478k net bonds (100:-126)
year 1: $446k stocks, $191k bonds, $554k mortgage = -$363k net bonds (100: -81)
year 2: $519k stocks, $222k bonds, $467k mortgage = -$245k net bonds (100: -47)
year 3: $595k stocks, $255k bonds, $377k mortgage = -$123k net bonds (100: -21)
year 4: $675k stocks, $289k bonds, $286k mortgage =    $3k net bonds (100:   0)
year 5: $760k stocks, $326k bonds, $193k mortgage =  $133k net bonds ( 85:  15)
year 6: $849k stocks, $364k bonds,  $98k mortgage =  $266k net bonds ( 76:  24)
year 7: $943k stocks, $404k bonds,   $0k mortgage =  $404k net bonds ( 70:  30)
If that glide path to your 70:30 gross and net asset allocation seems fine, then paying down the mortgage could be your choice. Where choosing to make less principal curtailment means your net bonds is negative for longer than the 4 years of your Option A.
That looks pretty good to me, we'll see how smooth the ride is in the real world. And thanks, again, for your thoughts!
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
harikaried
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by harikaried »

Hah. Because I already had put together a spreadsheet to calculate the net bonds glide path, I started playing around with the numbers for the various Options, and in general, the relative differences aren't actually that much, so that's probably why there's so much back and forth about paying off mortgages. As Taylor Larimore likes to say, "When experts disagree, it is often because it does not make much difference."

At a high level, yes investing more in stocks with higher expected growth returns more, and deciding between paying down mortgage or investing in bonds returns/costs the relatively little rate difference. But the most important aspect is actually "saving" the money whether towards investments or debt repayment as opposed to just spending it, and viewing debt as negative bonds makes it clearer that either usage of the savings is pretty much equivalent.
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Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

harikaried wrote: Tue Apr 13, 2021 11:53 am Hah. Because I already had put together a spreadsheet to calculate the net bonds glide path, I started playing around with the numbers for the various Options, and in general, the relative differences aren't actually that much, so that's probably why there's so much back and forth about paying off mortgages. As Taylor Larimore likes to say, "When experts disagree, it is often because it does not make much difference."

At a high level, yes investing more in stocks with higher expected growth returns more, and deciding between paying down mortgage or investing in bonds returns/costs the relatively little rate difference. But the most important aspect is actually "saving" the money whether towards investments or debt repayment as opposed to just spending it, and viewing debt as negative bonds makes it clearer that either usage of the savings is pretty much equivalent.
I ran out a Monte Carlo simulation sampling from the last 1200 months of real stock returns (*past performance is no guarantee of future returns, I know) and the expected value of investing in stocks compared to paying the mortgage is +$110k (after tax drag). The 90th percentile best case has us ahead by around $300k. The 10th percentile worst case has us behind by around $60k. Just about an 80% chance to at least break even.

I agree that the important thing is to actually save the money -- however, it does seem like it could be a six figure decision on how best to turn that savings into a paid off house, which is why it's been worth spending some time and energy thinking about it.

For what it's worth, I think we'll pursue Option C. There's something solid about putting $1 into an investment account for every $1 extra paid on the mortgage. It's arbitrary I guess, but feels about right in terms of risk tolerance and potential reward.

I'll come back here in a few years and update the post with the results.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
harikaried
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by harikaried »

Scooter K wrote: Tue Apr 13, 2021 12:11 pmFor what it's worth, I think we'll pursue Option C. There's something solid about putting $1 into an investment account for every $1 extra paid on the mortgage. It's arbitrary I guess, but feels about right in terms of risk tolerance and potential reward.
Seems reasonable. Sounds like my quick spreadsheet is not as fancy as yours with Monte Carlo simulations, but assuming your ARM doesn't actually change after 7 years and that you invest what would have gone into principal curtailment even after paying off the mortgage, after 12 years Option A would have $3,005k invested (mortgage paid off 7th year) while Option C has $3,074k invested (mortagge paid off 12th year), so a difference of $69k which is indeed not nothing but as a percentage of the total invested it's 2%.

But the main question that I have is you said neither you nor wife were happy with the 70/30 gross asset allocation, so does knowing the net asset allocation is actually more aggressive while you have debt at least make you feel better? In fact, if you went with a 50/50 gross asset allocation but paid off the debt slower, e.g., only paying down $17.5k extra principal each year (another half-step now between B and C) instead of A's $70k/yr or C's $35k/yr, it seems like you would end up with $3,025k invested (although there would still be a little bit of mortgage to pay off still unreasonably assuming rate didn't change), so you could tell wife your asset allocation is what she wanted :wink: while having a more aggressive net allocation.

(Separately, you could also explain to wife that the house (vs renting) allows you to have a more aggressive asset allocation as the house effectively pays your rent / reduces your expenses. Yes you do have a mortgage payment in the mean time, but that will go away.)
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Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

harikaried wrote: Sun Apr 18, 2021 12:13 pm
Scooter K wrote: Tue Apr 13, 2021 12:11 pmFor what it's worth, I think we'll pursue Option C. There's something solid about putting $1 into an investment account for every $1 extra paid on the mortgage. It's arbitrary I guess, but feels about right in terms of risk tolerance and potential reward.
Seems reasonable. Sounds like my quick spreadsheet is not as fancy as yours with Monte Carlo simulations, but assuming your ARM doesn't actually change after 7 years and that you invest what would have gone into principal curtailment even after paying off the mortgage, after 12 years Option A would have $3,005k invested (mortgage paid off 7th year) while Option C has $3,074k invested (mortagge paid off 12th year), so a difference of $69k which is indeed not nothing but as a percentage of the total invested it's 2%.

But the main question that I have is you said neither you nor wife were happy with the 70/30 gross asset allocation, so does knowing the net asset allocation is actually more aggressive while you have debt at least make you feel better? In fact, if you went with a 50/50 gross asset allocation but paid off the debt slower, e.g., only paying down $17.5k extra principal each year (another half-step now between B and C) instead of A's $70k/yr or C's $35k/yr, it seems like you would end up with $3,025k invested (although there would still be a little bit of mortgage to pay off still unreasonably assuming rate didn't change), so you could tell wife your asset allocation is what she wanted :wink: while having a more aggressive net allocation.

(Separately, you could also explain to wife that the house (vs renting) allows you to have a more aggressive asset allocation as the house effectively pays your rent / reduces your expenses. Yes you do have a mortgage payment in the mean time, but that will go away.)
Haha, well, between you, me, and the internet I'm okay with our effective asset allocation being more aggressive then 70/30 while we pay down the mortgage. :wink:

I just (on Friday) paid $3000 of the mortgage principal and put $3000 into VTSAX, so the great Option C: 50/50 experiment is afoot. Still planning on paying the whole thing down before the 7 year adjustment, however things turn out.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
YerYer
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by YerYer »

I like option C.

I'll also add Given the expected in increases to income and the education investment of her career, I would make sure your spouse has disability insurance and continue to add to this as her income increases.
hnd
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by hnd »

we invest our extra in an allocation fund of stocks and bonds. about 80/20. the plan is to take a peek at 7 years and see what we should do.

The SP500 has historically given a positive return on your money, over a period of 5 years, 90% of the time. 10 yr period is 95% of the time. obviously not 100% but considering I don't HAVE to have the house paid off, its a risk we are willing to take.
srt7
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by srt7 »

Scooter K wrote: Sun Apr 11, 2021 7:35 pm

1) We have a 900k house and a net worth around 900k. If the house crashed 50% and did not recover for 10 years, it wouldn't matter to me. One thing that's maybe hidden in the background information I gave is that until 2019 my wife has been going through medical school and residency, so it's only recently that her income went from negative 30k (as a student) to positive 50k (as a resident) to positive 250k (as an attending). I know the 530k we have in retirement assets might not be too impressive given our age, but we're on something of a different glidepath then we were a few years ago, and we're saving 50% of our money each year.

....
Well, that (bolded part) changes everything. I would highly recommend you edit your original post to include it.
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Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

srt7 wrote: Sun Apr 18, 2021 7:03 pm
Scooter K wrote: Sun Apr 11, 2021 7:35 pm

1) We have a 900k house and a net worth around 900k. If the house crashed 50% and did not recover for 10 years, it wouldn't matter to me. One thing that's maybe hidden in the background information I gave is that until 2019 my wife has been going through medical school and residency, so it's only recently that her income went from negative 30k (as a student) to positive 50k (as a resident) to positive 250k (as an attending). I know the 530k we have in retirement assets might not be too impressive given our age, but we're on something of a different glidepath then we were a few years ago, and we're saving 50% of our money each year.

....
Well, that (bolded part) changes everything. I would highly recommend you edit your original post to include it.
I think all that information is in the original post. I was just responding to Klangfool's assertion that we're house poor. It's true that the house is a pretty big part of our net worth at the moment, but I was emphasizing that our trajectory is a bit different now compared to two years ago. As a ratio to our income, I don't think we're house poor. As a percentage of our assets, I guess sure, maybe. Though maybe we're house rich?
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
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Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

srt7 wrote: Sun Apr 18, 2021 7:03 pm
Scooter K wrote: Sun Apr 11, 2021 7:35 pm

1) We have a 900k house and a net worth around 900k. If the house crashed 50% and did not recover for 10 years, it wouldn't matter to me. One thing that's maybe hidden in the background information I gave is that until 2019 my wife has been going through medical school and residency, so it's only recently that her income went from negative 30k (as a student) to positive 50k (as a resident) to positive 250k (as an attending). I know the 530k we have in retirement assets might not be too impressive given our age, but we're on something of a different glidepath then we were a few years ago, and we're saving 50% of our money each year.

....
Well, that (bolded part) changes everything. I would highly recommend you edit your original post to include it.
Not to harp on it, but specifically my question was what else should I consider given that I have an extra $5800 per month to spend on paying down a $640k 7/1 ARM that will adjust in May 2028. Just given those parameters, what would you consider? I put information about income, assets, and liabilities as that would change how much risk to take. Income seems stable, job seems stable, no other debts. Pay it straight down or invest it and expect to net the spread between market return and mortgage interest rate (2.125%). We're pursuing the Option C choice of putting half directly on the mortgage and investing the other half, but I'm open to hearing more ideas on the subject.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
rockstar
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by rockstar »

The stock market can return zero for the next decade. Returns bounce around a lot. There will be some years where your return will be less than your mortgage rate. There will be years where it greatly exceeds your 8% expectation.

What's your plan to deal with volatility? How do you plan to stick to your plan?
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Scooter K
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Re: Mortgage Payoff vs Taxable Account - What else should I consider?

Post by Scooter K »

rockstar wrote: Sun Apr 18, 2021 7:46 pm The stock market can return zero for the next decade. Returns bounce around a lot. There will be some years where your return will be less than your mortgage rate. There will be years where it greatly exceeds your 8% expectation.

What's your plan to deal with volatility? How do you plan to stick to your plan?
Well, if the next decade is zero returns, that's probably fabulous news for us, as we're in our prime working and investing/saving years. Though it means we'd probably not pay off the mortgage before it adjusts, it also means we put ~$900k into the stock market while stocks were increasingly on sale. Provided it bounces back in the following decades, that'd be great news. I guess in a way investing the mortgage fund is sort of a hedge -- if the market does really well we'll pay off the mortgage sooner but likely have worse long term returns on our retirement accounts. If the market does poorly, we'll pay off the mortgage more slowly but likely have better long term returns on our retirement accounts.

It's a good question though, best to have things written down and committed to ahead of time. My plan is to liquidate the taxable account in the year leading up to May 2028, to apply those funds towards our mortgage.
"If you act on the assumption that every financial advisor you encounter is a hardened criminal, you will do just fine." Bernstein
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