Pay Off Our Mortgage or Invest Heavily?

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Better Than Aliens
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Pay Off Our Mortgage or Invest Heavily?

Post by Better Than Aliens »

Hi! I'm new to the forum and recently finished the Bogleheads Guide to Investing - began the great video series via the Wiki today. But this whole world is brand new to me. I had always lived for today and not thought at all about tomorrow. But want to be smarter starting today!

My wife and I have joked - but we want to be serious - about buckling down and being "free and clear" on our home. We've only been in our house for 4.5 years and our debt is about $510,000. Our interest rate is 2.875% Our combined annual income is about $400K. 41 and 42 years old with two youngish children.

-We have an emergency fund
-minimal debts beside one student loan
-max out our 401K and 403bs each year
-recently sold a 2nd home and are sitting on about 150K looking for a home
-most extra money is simply sitting in savings account not doing much. both of us are in the complete infancy stages of learning what investing is

Since the interest rate is so low, does it make sense to put any "extra money" towards the home? Or should we set up an account to begin investing?

Personally, the idea of not having a mortgage sounds pretty amazing. But no time like the present to let the magic of compound interest begin working for us. Any thoughts are appreciated! Thanks!
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JoeRetire
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by JoeRetire »

Better Than Aliens wrote: Mon Dec 21, 2020 4:43 pm My wife and I have joked - but we want to be serious - about buckling down and being "free and clear" on our home. We've only been in our house for 4.5 years and our debt is about $510,000. Our interest rate is 2.875%
If you are wedded to the idea of being "free and clear", then the choice is obvious.

Otherwise, I would never hurry to pay off a 2.875% loan.
It's the end of the world as we know it. | It's the end of the world as we know it. | It's the end of the world as we know it. | And I feel fine.
Gill
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by Gill »

What about the student loan? Wouldn't it make sense to pay that off? Where has your money been going?
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Quirkz
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by Quirkz »

Welcome!

I think the consensus here is tax advantaged investing will come before mortgage payoff, but since you're already maxing those options out, what comes next is a bit more of a personal choice. Your interest rate is pretty low, so there's definitely a case that you could get more out of investments than from the payoff, but it's hard to put a price on the satisfaction of having a paid-off house.

Of course you could also go 50-50 or split it some other way. And some would prefer to invest until they can completely pay off the house in one lump sum, and then transfer the money. You can't know in advance what'll be the best choice, but none of these options are bad.
k3vb0t
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by k3vb0t »

You owe $510k. You have an extra $150k.

In my opinion paying off the mortgage is all or nothing. It doesn’t do you much good to take your mortgage from $510k to $360k. You still have the debt. You still have the monthly payment. It becomes much more difficult to get the money back out should you need it. Your cash flow hasn’t changed because you still have the payment.

I would invest in an after tax portfolio that helps you to sleep at night until it reaches a point where you can pay it off in a lump (if that’s what you decide you want to do at that point).
Invest2027
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by Invest2027 »

Yes. :sharebeer
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MedicatedMoney
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by MedicatedMoney »

Welcome BTA!

Personally, I would use the money for "other" things instead of the mortgage like:
- Paying off the student loan
- Investing in a taxable account
- Investing in a 529

I say this because I don't put the same weight into paying off the mortgage as other Bogleheads. Especially when it is a very low rate (which you have) and when one has a high income (which you do). IMHO, the money put to use in other areas will probably benefit you more than paying a 2.875% note. But again, one could the other side of the coin and not be wrong!
-Medicated
Admiral
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by Admiral »

Better Than Aliens wrote: Mon Dec 21, 2020 4:43 pm Hi! I'm new to the forum and recently finished the Bogleheads Guide to Investing - began the great video series via the Wiki today. But this whole world is brand new to me. I had always lived for today and not thought at all about tomorrow. But want to be smarter starting today!

My wife and I have joked - but we want to be serious - about buckling down and being "free and clear" on our home. We've only been in our house for 4.5 years and our debt is about $510,000. Our interest rate is 2.875% Our combined annual income is about $400K. 41 and 42 years old with two youngish children.

-We have an emergency fund
-minimal debts beside one student loan
-max out our 401K and 403bs each year
-recently sold a 2nd home and are sitting on about 150K looking for a home
-most extra money is simply sitting in savings account not doing much. both of us are in the complete infancy stages of learning what investing is

Since the interest rate is so low, does it make sense to put any "extra money" towards the home? Or should we set up an account to begin investing?

Personally, the idea of not having a mortgage sounds pretty amazing. But no time like the present to let the magic of compound interest begin working for us. Any thoughts are appreciated! Thanks!
Welcome.

Please post your complete portfolio, including retirement account balances. It's important to know your debt as a portion of your overall assets.

You may be saving the max in retirement accounts, but that could mean you have $50k or $500k.

If it's anywhere in between those two, you should not put more money into your home.

For now, all we know is you have a lot of debt and a lot fewer assets.
Adfmacro
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by Adfmacro »

One option is to put the money in a separate account for the purpose of some day paying off the house or to reduce a mortgage during a refi. If no refi, build it up until there is enough to pay off the balance. With over $500k in debt and $150k available, it could take a while. Paying the 150k to reduce the principal, will not change your monthly payment, but will have more of that payment go to principal each month. You can do that, but with the same payment, it may not feel that you have accomplished what you desired.

Another option is to increase your monthly payment to pay off the loan by a specific date. If you did that, you would draw that extra payment from the 150k.

My point is that there my be more options that might be worth considering and still be working toward a paid off home you desire.
scifilover
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by scifilover »

If your children are under 10 years old, I would begin funding their college now by making substantial 529 contributions, say $30k each. With at least 8 years to go before college, these funds would have time for significant appreciation before need arrived. If you choose an age adjusted investment option the work of managing these funds will be minimal. As time passes you can add additional funds. If your state 529 fund isn't among the most highly rated choose a different state's fund, such as Utah.

I'd guess that your student loan interest rate is double your mortgage's rate. I would pay that loan off.

With the remaining funds you could begin investing in a taxable account.

If you are really interested in reducing/eliminating your mortgage, you could consider a number of options....
1) Refinance to a 15 year mortgage using a portion of your 2nd home sale for closing costs. Your interest rate would be lower, and you would be done paying for your house at age 57/58, getting ready for retirement.

2) Make one or two additional payments each year on the principal.
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galawdawg
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by galawdawg »

Welcome to Bogleheads!

For more informed advice, you may wish to consider posting more complete information in the recommended format: https://www.bogleheads.org/wiki/Asking_ ... _questions

By providing some details about your current portfolio, your current income and expenses, your current assets as well as debts and interest rates, we can better assist you with a wise strategy, including the advisability of paying down debt vs. investing.

Again, welcome!
jmann2380
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by jmann2380 »

Hi, my wife and I were in a very similar situation earlier this year and around the same age with a 2yo and another on the way. I'm self-employed and she stays home with the kid(s). We have similar incomes and I max my SIMPLE IRA. We had the cash to pay off our mortgage sitting in the bank and were trying to decide to put it in a taxable account or pay off our mortgage. It's a very personal choice.

We decided to pay off the mortgage and own our home free and clear. It certainly is not the "optimal" financial choice, however it was the best choice for us... I think :)

Although some would argue that being self-employed means I should preserve cash for a rainy day and keep my mortgage, I felt the opposite. I'd rather reduce our monthly obligations and in the event things go south with my company, I'd rather hunker down, reduce expenses even further to weather the storm, knowing we will always have a home. I don't want to use my savings to keep our current lifestyle. That seems irresponsible.

I still think about the decision and look the current mortgage rates and ponder our choice. BUT I always circle back to how having no debt gives us satisfaction and sort of "hacks" us into better spending habits vs. a pile of cash in the bank or a brokerage.

Good luck with the decision!
tashnewbie
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by tashnewbie »

Welcome to the forum.

What’s the student loan amount and interest rate?

What’s your general portfolio size?

Do you do backdoor Roth IRA contributions for both spouses? I’d start here if you don’t.
qwertyjazz
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by qwertyjazz »

Neither - take 3 months and self educate on investments. Read the wiki attached to this forum. Maybe read some of the suggested books. Compounding works when it is uninterrupted. So you need to make a plan you can hold onto for decade plus. So then make a plan. Write it down (IPS can use wiki format)
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by smatter »

I was in a similar situation a few months back - you can read about it here: viewtopic.php?f=1&t=300348&p=4950733#p4950733

We ended up paying down a portion of our mortgage with our free cash and refinancing into a 10/1 ARM that we are paying like a 15. We may refinance again with 15 year rates close to 2%.

To answer the question for you I agree with most here. We need more information about your situation. Is the 150K your entire taxable investment portfolio? Also, what is the value of the house?
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FelixTheCat
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by FelixTheCat »

I worked for mega corp. Over a six year period the company laid off 85% of the personnel. People were living in absolute fear because they didn't have a plan. I paid off my house early. Then I took the mortgage payment and accelerated my investing. When my day came, I just smiled.

Life happens. IF you lost your income, what would make you feel better? A paid off house or money in the bank?
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newguy123
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by newguy123 »

I had a similar thread but I have a paid off house and wanted to do a refi to take out money to invest. I thought it through and a paid off house helps me sleep at night. Plus the area I am in appreciated 10% this year and is predicted to appreciate 9.5% according to zillow/redfin next year. Just that alone matches the average market return so I am not going to sweat it if the market returns 30-40% next year as I am not going into debt trying to beat the market. In the time of need I can also use my house like an ATM machine and do a cash out refi down the road. Lastly, you can go YOLO when everything is paid off which is what I am doing since I can now be super risky in my investments since I am financially independent , this is just my experience / thoughts on it
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mrtwstr
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by mrtwstr »

It is an emotional high/relief to own the house free and clear. Maybe not the best choice financially but rewarding emotionally.
LittleMaggieMae
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by LittleMaggieMae »

with out knowing how much you have in retirement savings I vote that you should invest the the 150K and NOT put it towards the mortgage.

I'm another person who's ok with low interest/manageable mortgage (PITI) payments. A low interest/manageable mortgage (PITI) serves a purpose. You have someplace to live. the monthly/yearly cost is somewhat fixed and predictable. if the mortgage payment, prop taxes, and insurance cost fits comfortably into your spending plan/budget and future financial plans when you initially purchased the house - then that should let you save/invest your future income growth - if you don't succumb to continuously upgrading your lifestyle.

If you want to have "I paid my mortgage off early" bragging rights - why not play around with an amortization schedule and see how much you need to add to your monthly payment (that will go towards principal) to reach a paid off mortgage on a "nice to you" future date (the first kid goes to college? A special wedding anniversary? Some other commemorative future date). And then do that. People who say they paid off their mortgage early don't generally elaborate on HOW early it was.

Also, don't forget that even a paid off house is an expense. Property Taxes, Insurance(s), maintenance, repairs. Some of which can be large expenses.

(OK, I'm biased - all of my mortgages are small. PI payments have been close to or smaller than the taxes/insurance part of the payment. Paying off my biggest mortgage would free up a whopping 650 per month. Not particularly life changing for me.)
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by grabiner »

FelixTheCat wrote: Tue Dec 22, 2020 1:13 pm I worked for mega corp. Over a six year period the company laid off 85% of the personnel. People were living in absolute fear because they didn't have a plan. I paid off my house early. Then I took the mortgage payment and accelerated my investing. When my day came, I just smiled.

Life happens. IF you lost your income, what would make you feel better? A paid off house or money in the bank?
This is actually an argument for not paying off the mortgage. If you lose your income, it is better to have $100K in debt which is not all due now, and $100K in cash, rather than no debt and no cash. With both the cash and the debt, you will spend some of it on debt payments, but you can also spend it on other living expenses. (And you retain the option of paying off the mortgage later if appropriate).

Now, you do pay a cost for this, because the cash will usually earn less than the mortgage rate, even if it is invested in a low-risk bond fund rather than actual cash. At the moment, Admiral shares of Vanguard Long-Term Tax-Exempt yield 1.40%, which is less than the rate on most mortgages even if the interest is tax-deductible. You have to decide whether this cost is worth the liquidity. (For me, it wasn't; I paid off my mortgage in March for a 1.78% yield after tax, rather than investing in munis yielding 1.14% after tax, but I still had a large taxable account if I needed liquidity.)
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just_cruisin
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by just_cruisin »

Paying the 150k against the 510k debt will just deplete your cash reserves and not lower your payments.

You will end up paying off the mortgage a few years sooner, but that is many years down the road in both scenarios.

I just paid off a mortgage myself and it feels great, but it’s simpler to do it when you have enough to do it in one shot.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by abuss368 »

There are TWO SIDES to a Balance Sheet. Business or Personal.

How about focusing on BOTH sides as an alternative?

I build cash and invest but also PAY DOWN debt faster.

Over time this compounds quite fast.

Then at least it is not an either or. In my opinion too often the discussion is too often one or the other!

THINK DIFFERENT!

I have cash and investments and debt is becoming less and less of an issue.

Best.
Tony
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capthawk
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by capthawk »

Paid off my house at age 48. With your 400k income, you should achieve the same result. It feels wonderful!
LeslieSmiley
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by LeslieSmiley »

Better Than Aliens wrote: Mon Dec 21, 2020 4:43 pm Hi! I'm new to the forum and recently finished the Bogleheads Guide to Investing - began the great video series via the Wiki today. But this whole world is brand new to me. I had always lived for today and not thought at all about tomorrow. But want to be smarter starting today!

My wife and I have joked - but we want to be serious - about buckling down and being "free and clear" on our home. We've only been in our house for 4.5 years and our debt is about $510,000. Our interest rate is 2.875% Our combined annual income is about $400K. 41 and 42 years old with two youngish children.

-We have an emergency fund
-minimal debts beside one student loan
-max out our 401K and 403bs each year
-recently sold a 2nd home and are sitting on about 150K looking for a home
-most extra money is simply sitting in savings account not doing much. both of us are in the complete infancy stages of learning what investing is

Since the interest rate is so low, does it make sense to put any "extra money" towards the home? Or should we set up an account to begin investing?

Personally, the idea of not having a mortgage sounds pretty amazing. But no time like the present to let the magic of compound interest begin working for us. Any thoughts are appreciated! Thanks!
your mortgage interest rate is low. so if you have a decent time horizon before retirement, it might be more financially prudent to invest the $150k in a diversified portfolio. but if the psychological factor of "free and clear" means a lot to you and consequently enhances the quality of your life in terms of "feeling", then perhaps that's a better choice for you. so it comes down to which factor is more important to you.
RDP
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by RDP »

One way to look at this is that if you currently owed 360k on your house would you borrow an extra 150k on your home in order to have an extra 150k to invest? I am a proponent of maxing out retirement accounts, having a large emergency fund, and paying off your house. The luxury of a paid for home has brought me much peace and serenity over the years. This peace and serenity is above and beyond the interest rate on your loan. From my perspective someone bragging about the low interest rate on their home loan is analogous to a prisoner bragging that he has the most comfortable jail cell in the prison. This is the philosophy that suits me but everyone is different and there are many paths that will get you where you want to be. Congrats on being in this position!

RDP
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by MathIsMyWayr »

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Last edited by MathIsMyWayr on Mon Jan 04, 2021 11:35 am, edited 3 times in total.
CurlyDave
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by CurlyDave »

While many extol the benefits of owning a home free and clear, IMHO there is no such thing. Unless you move to a very remote place, you will always have property taxes, which are a periodic payment necessary for your home. A mortgage just means the payment is larger.

I am 75, have had mortgages for 48 years and just refinanced four, count them, four mortgages to 30 year fixed terms. (Three are on rental properties.) I have never lost any sleep over paying mortgages. Even when I was between jobs.

You interest rate is very good, and the odds are overwhelmingly in your favor that investing the money will produce a better return than paying down the mortgage. When analyzing this situation remember that mortgages are paid back in then-year nominal dollars, i.e. not inflation-adjusted dollars, so compare nominal stock market returns to the mortgage rates, not inflation-adjusted market returns.

Putting the money in a taxable account also produces a second benefit -- liquidity. What happens if you lose your job or have an accident and can't work a few years down the road? Even if you give that $150k to the mortgage holder right now, he will still want his payments every month until the whole thing is paid off. If you are fortunate, the mortgage holder may re-cast the mortgage to reduce your payments to reflect the large principal payment you made, but they will charge you for the "service" and most will not do it automatically. OTOH, $150k will make a lot of payments on that mortgage and give you a lot of breathing room to adapt to any change necessary. Even if the $150k is subject to the vagaries of the market it is still not going to zero.

And, you can not ever count on the idea of getting the money back by taking out a HELOC or a second mortgage. The changed circumstances that led to a need for cash most likely make it impossible to borrow that cash.

All my life I have invested extra cash instead of paying down mortgages, and for very close to half a century it has benefited me greatly.
lakpr
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by lakpr »

I am firmly in the camp of paying down the mortgage. The indicated mortgage balance of $510k, is just about the amount where the tax deductibility disappears. In other words, the mortgage interest being paid is all after tax. [ $14,800 is the difference between standard deduction and SALT limit, $14,800÷2.875% = $514k ]

With a stated annual income of $400k, the OP is in a 32% federal tax bracket. OP didn't indicate which state he is in, let me assume a middle of the road state tax rate of 5%. That makes the 2.875% rate he is paying, really, an equivalent of a 4.56% CD on which taxes are owed on earnings.

Paying down the mortgage, then, can be reframed as an offer of hypothetical CD that pays 4.56% over the next 25 years guaranteed. The only caveats on this offer are that the term is fixed: 25 years; the max amount one can invest is fixed: $510k; and the early withdrawal penalty is approximately 6% of the entire initial investment balance, earned or unearned, that discourages breaking the CD (real estate commissions + real estate sales taxes).

Would the OP jump at the offer? Or would the OP say the guaranteed interest rate is low and take chances in equities?

I have already stated my choice in the first sentence of this post
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by willthrill81 »

You can't go wrong either way. I would recommend choosing the option that excites you the most as you will almost certainly put more money toward that one rather than the other.

Paying off our mortgage early really excited my DW, and I was fine with it, so that's what we did. Now that it's gone, we're putting half of our gross income into stocks.

In order for those who are saying that it's a slam dunk to invest rather than pay down a mortgage to be consistent, they should have the basically the same attitude toward owning stocks vs. bonds (i.e. own stocks rather than bonds). And if they're really that confident in stocks, they should consider leveraging them.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by geerhardusvos »

Better Than Aliens wrote: Mon Dec 21, 2020 4:43 pm Personally, the idea of not having a mortgage sounds pretty amazing.
Sounds like you answered your question here. You have a chance of doing slightly better financially by continuing to invest aggressively and paying off your mortgage per the normal monthly schedule. But if being out of debt makes you feel good, go for it. Sounds like you guys make enough money that you can probably do both. Don’t overthink it! Follow your gut. Keep investing either way is my advice.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by bling »

how about refinancing every 5 years to a new 30 year (assuming rates remain the same and/or get lower) and continuing to invest the difference? :sharebeer
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grabiner
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by grabiner »

lakpr wrote: Fri Dec 25, 2020 3:40 pm I am firmly in the camp of paying down the mortgage. The indicated mortgage balance of $510k, is just about the amount where the tax deductibility disappears. In other words, the mortgage interest being paid is all after tax. [ $14,800 is the difference between standard deduction and SALT limit, $14,800÷2.875% = $514k ]
This depends on how much they donate to charity. If they donate a lot to charity, paying down the mortgage would reduce deductible interest, making the return equivalent to 2.875% taxable, which is no longer as attractive.
lakpr wrote: Fri Dec 25, 2020 3:40 pm Paying down the mortgage, then, can be reframed as an offer of hypothetical CD that pays 4.56% over the next 25 years guaranteed. The only caveats on this offer are that the term is fixed: 25 years; the max amount one can invest is fixed: $510k; and the early withdrawal penalty is approximately 6% of the entire initial investment balance, earned or unearned, that discourages breaking the CD (real estate commissions + real estate sales taxes).
The term is usually shorter, which makes this slightly more attractive.

Only the first dollars paid down have a 25-year term. If you pay down the mortgage enough to shorten the term from 25 years to 15, then you have a portfolio of CDs maturing in 15-25 years, which is only a 20-year term. If you pay off the whole thing, the average duration of the CDs is about 10 years.

And the term is shortened if you sell the house, as you get back the reduced mortgage balance at closing. If you sell in 10 years, you get the equivalent of buying 10-year bonds or CDs.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by neverpanic »

Everyone is excited when the bulls come to town, especially if they seem to stick around for a while.

Hindsight is better than 20/20 - I haven't run a full calculation, but IF I had chosen to invest in the market vs paying off the home, I would have significantly more cash available now. But the past decade was unprecedented in terms of growth. Who knows what comes next? Part of the reason I chose to get the home paid off was that my effective interest rate was almost 6% and I had grown up with "get the home paid off" training. In retrospect, I would rather have 2-3x more cash which would have enabled me to write a payoff check at some point a few years earlier.

But I didn't have a 2.875% interest rate back then. You do. And you're smarter than I was, so keep the mortgage for now and get your money working for you.
I am not a financial professional or guru. I'm a schmuck who got lucky 10 times. Such is the life of the trader.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by abuss368 »

I would consider extra payments until your cash is higher and mortgage lower. If you apply the $150,000 and something in life impacts your income steam, the bank is still going to want that months payment.

Bank the cash and pay extra principal each month.

Then revisit in the future.

Tony
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by lakpr »

grabiner wrote: Sat Dec 26, 2020 4:28 pm
lakpr wrote: Fri Dec 25, 2020 3:40 pm I am firmly in the camp of paying down the mortgage. The indicated mortgage balance of $510k, is just about the amount where the tax deductibility disappears. In other words, the mortgage interest being paid is all after tax. [ $14,800 is the difference between standard deduction and SALT limit, $14,800÷2.875% = $514k ]
This depends on how much they donate to charity. If they donate a lot to charity, paying down the mortgage would reduce deductible interest, making the return equivalent to 2.875% taxable, which is no longer as attractive.
True, but that's a matter of perspective isn't it? I will argue that they are reaping the full benefit of charitable giving, in other words, the tax benefit is being exclusively derived by the charitable donations rather than by the mortgage interest (very similar to how it was in 2017, prior to TCJA).
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by grabiner »

lakpr wrote: Sat Dec 26, 2020 4:53 pm
grabiner wrote: Sat Dec 26, 2020 4:28 pm
lakpr wrote: Fri Dec 25, 2020 3:40 pm I am firmly in the camp of paying down the mortgage. The indicated mortgage balance of $510k, is just about the amount where the tax deductibility disappears. In other words, the mortgage interest being paid is all after tax. [ $14,800 is the difference between standard deduction and SALT limit, $14,800÷2.875% = $514k ]
This depends on how much they donate to charity. If they donate a lot to charity, paying down the mortgage would reduce deductible interest, making the return equivalent to 2.875% taxable, which is no longer as attractive.
True, but that's a matter of perspective isn't it? I will argue that they are reaping the full benefit of charitable giving, in other words, the tax benefit is being exclusively derived by the charitable donations rather than by the mortgage interest (very similar to how it was in 2017, prior to TCJA).
But it affects the decision whether to pay off the mortgage. I would have paid off my own mortgage several years earlier if I didn't donate enough to charity to itemize deductions, as the risk-free 2.625% return would have been a good deal. But 2.625% was only 1.88% after tax (24% federal and 8.2% MD), and I could earn more than that on municipal bonds until rates dropped in 2019-2020. Even without the mortgage, I still itemize because I donate enough to charity plus SALT to cover the standard deduction.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by d0gerz »

grabiner wrote: Sat Dec 26, 2020 4:28 pmThis depends on how much they donate to charity. If they donate a lot to charity, paying down the mortgage would reduce deductible interest, making the return equivalent to 2.875% taxable, which is no longer as attractive.
Would you mind elaborating on this? Why would deductible mortgage interest be reduced if donating a lot to charity?
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by lakpr »

d0gerz wrote: Sat Dec 26, 2020 5:53 pm
grabiner wrote: Sat Dec 26, 2020 4:28 pmThis depends on how much they donate to charity. If they donate a lot to charity, paying down the mortgage would reduce deductible interest, making the return equivalent to 2.875% taxable, which is no longer as attractive.
Would you mind elaborating on this? Why would deductible mortgage interest be reduced if donating a lot to charity?
After the Tax Cuts and Jobs Act had passed, the SALT (state and local taxes) are limited to $10,000 annually. *No inflation adjustment!!*
The standard deduction on the other hand, is indexed to inflation. For 2020 it was $24,800.

The difference is $14,800 (for Married Filing Jointly).

The only things that are left and itemizable as deductions (remember SALT is already taken out!) are mortgage interest and charitable deductions.
[Edit: someone sent me a PM that said medical expenses exceeding a 10% threshold are also itemizable, but that's not being discussed here ]
The sum of these two items must exceed $14,800.
If the sum does NOT exceed $14,800 then the couple is better off taking the standard deduction instead on their tax returns.
And by taking the standard deduction, implicitly the tax-deductibility of one or both of the mortgage interest and charitable deductions are lost.

If you donate a lot to charity, then the amount of mortgage interest needed to reach the $14,800 threshold is less.
Conversely, if there is a lot of mortgage interest, the amount of charitable donations needed to meet the threshold is less.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by beernutz »

Paying off (or down) a mortgage, like owning a home, is a lifestyle choice.

I paid off a 2nd home mortgage in September and it felt great but it was a lot different situation than yours.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by d0gerz »

lakpr wrote: Sat Dec 26, 2020 6:06 pm
d0gerz wrote: Sat Dec 26, 2020 5:53 pm
grabiner wrote: Sat Dec 26, 2020 4:28 pmThis depends on how much they donate to charity. If they donate a lot to charity, paying down the mortgage would reduce deductible interest, making the return equivalent to 2.875% taxable, which is no longer as attractive.
Would you mind elaborating on this? Why would deductible mortgage interest be reduced if donating a lot to charity?
After the Tax Cuts and Jobs Act had passed, the SALT (state and local taxes) are limited to $10,000 annually. *No inflation adjustment!!*
The standard deduction on the other hand, is indexed to inflation. For 2020 it was $24,800.

The difference is $14,800 (for Married Filing Jointly).

The only things that are left and itemizable as deductions (remember SALT is already taken out!) are mortgage interest and charitable deductions.
[Edit: someone sent me a PM that said medical expenses exceeding a 10% threshold are also itemizable, but that's not being discussed here ]
The sum of these two items must exceed $14,800.
If the sum does NOT exceed $14,800 then the couple is better off taking the standard deduction instead on their tax returns.
And by taking the standard deduction, implicitly the tax-deductibility of one or both of the mortgage interest and charitable deductions are lost.

If you donate a lot to charity, then the amount of mortgage interest needed to reach the $14,800 threshold is less.
Conversely, if there is a lot of mortgage interest, the amount of charitable donations needed to meet the threshold is less.
Thanks, yeah I get all that. What I'm missing is what this has to do with the decision of paying off the mortgage early. Whether I take the standardized deduction or itemize, what difference does it make?
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by k3vb0t »

d0gerz wrote: Sat Dec 26, 2020 8:31 pmThanks, yeah I get all that. What I'm missing is what this has to do with the decision of paying off the mortgage early. Whether I take the standardized deduction or itemize, what difference does it make?
The deductibility (or not) of mortgage interest changes the rate of return you get by paying it off. If your mortgage rate is 3% but you can deduct some of the interest then it isn’t costing you a full 3%.

Whatever the actual rate it is costing you would be compared to alternatives, like investing in stocks or bonds and comparing to their expected returns.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by lakpr »

d0gerz wrote: Sat Dec 26, 2020 8:31 pm Thanks, yeah I get all that. What I'm missing is what this has to do with the decision of paying off the mortgage early. Whether I take the standardized deduction or itemize, what difference does it make?
@grabiner is arguing that, if you do itemize, the last few dollars of the mortgage interest are effectively being subsidized at a combined Fed + State income tax rates. See his example above of saying he calculated the effective tax rate to be 1.88% using a 24% Fed + 8.2% state (MD) for HIS particular case. The same principle extended to the OP would make the effective mortgage interest as 2.875% * (1 - 0.32 - 0.05) = 1.81% (32% Fed + 5% state assumed, may be higher)

Or stated in other words, his argument is negating my own argument of 2.875% being after-tax rate and thus equivalent of 4.56%.

Is it 4.56% or 1.81% effective after-tax rate the OP would be paying, *IF* there are substantial charity donations the OP would be making?
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by grabiner »

lakpr wrote: Sat Dec 26, 2020 8:50 pm
d0gerz wrote: Sat Dec 26, 2020 8:31 pm Thanks, yeah I get all that. What I'm missing is what this has to do with the decision of paying off the mortgage early. Whether I take the standardized deduction or itemize, what difference does it make?
@grabiner is arguing that, if you do itemize, the last few dollars of the mortgage interest are effectively being subsidized at a combined Fed + State income tax rates. See his example above of saying he calculated the effective tax rate to be 1.88% using a 24% Fed + 8.2% state (MD) for HIS particular case. The same principle extended to the OP would make the effective mortgage interest as 2.875% * (1 - 0.32 - 0.05) = 1.81% (32% Fed + 5% state assumed, may be higher)

Or stated in other words, his argument is negating my own argument of 2.875% being after-tax rate and thus equivalent of 4.56%.

Is it 4.56% or 1.81% effective after-tax rate the OP would be paying, *IF* there are substantial charity donations the OP would be making?
Depending on the deductibility, the rate is 2.875% or 1.81% after tax, which is 4.56% or 2.875% pre-tax equivalent; 4.56% and 1.81% is not an equivalent comparison.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by Rlew »

Max out all tax advantages accounts before you pay extra on the mortgage. This should also include backdoor roth IRAs for you and your spouse, HSA (if you have a qualifying high deductible plan), and 529s to get the max annual state income tax break (if your state gives income tax break on 529 contributions & you plan to pay for your kids' higher education).

After that, do whatever you want. Mathematically you are more likely to come out ahead if you invest & keep the low interest mortgage. However, behaviorally you may find that you and your spouse are better about increasing your savings if you have a clearly defined goal (pay off the house). Some people here are also very debt averse (myself included) and find added comfort in being debt free, that is not easily quantified. As long as your understand the arguments for and against, I don't think there is a right or wrong answer. Do whatever makes you most comfortable.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by av111 »

OP

If you put 150k towards mortgage, you will get 2.875% guaranteed after tax return or about 5% pre tax

If you invest 150k in stocks you could gain another 20% or lose 30% next year

Depends on what you are comfortable with
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by mrspock »

Invest, the money you get at a young age is worth waaaaay more as an investor than the money you will get later. The money at 25 is worth 15x @ 8% CAGR. If you delay investing and wait till 35, you are now working with just 7x money at 8% CAGR. It’s a no brainer... invest young, use your 35+ monies if you want to pay it down early.

And honestly, once you get to a sizable nest egg — and cut cut a check any day for your mortgage balance you seriously stop caring about this debate. If people are going to rent me money for free (after inflation and tax deductions), I’m going to take it.

Build your index investing “bazooka”, then aim and point it at your mortgage one day and blow it out of the water with your dividends.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by d0gerz »

k3vb0t wrote: Sat Dec 26, 2020 8:46 pmThe deductibility (or not) of mortgage interest changes the rate of return you get by paying it off. If your mortgage rate is 3% but you can deduct some of the interest then it isn’t costing you a full 3%.

Whatever the actual rate it is costing you would be compared to alternatives, like investing in stocks or bonds and comparing to their expected returns.
lakpr wrote: Sat Dec 26, 2020 8:50 pm@grabiner is arguing that, if you do itemize, the last few dollars of the mortgage interest are effectively being subsidized at a combined Fed + State income tax rates. See his example above of saying he calculated the effective tax rate to be 1.88% using a 24% Fed + 8.2% state (MD) for HIS particular case. The same principle extended to the OP would make the effective mortgage interest as 2.875% * (1 - 0.32 - 0.05) = 1.81% (32% Fed + 5% state assumed, may be higher)
Thanks for the explanation, much appreciated.

With apologies to the OP for the thread hijack, in my situation I'll have enough deductions (due to bunching charitable giving) this year, and will take the standard deduction next year. All else being equal, do I then decide whether to pay down mortgage or not each year separately, according to my tax situation for that particular year?

In any event, per the wiki article on this topic, the appropriate comparison for the investing side of the equation is a bond investment with a similar risk. Given the low yields currently and the numbers being discussed here (2.875%/1.81%), this would point to paying off the mortgage being the better deal no matter what. What 30-year (or 25, as the case may be) risk-free bond yields 1.81% in today's market?
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by grabiner »

d0gerz wrote: Sun Dec 27, 2020 1:16 pm With apologies to the OP for the thread hijack, in my situation I'll have enough deductions (due to bunching charitable giving) this year, and will take the standard deduction next year. All else being equal, do I then decide whether to pay down mortgage or not each year separately, according to my tax situation for that particular year?
Since paying down the mortgage reduces your interest paid every year, you should look at an average effective rate. For example, if you bunch deductions to itemize every other year, and are in a 24% tax bracket, you should reduce the mortgage rate by 12% to compute the after-tax rate.
In any event, per the wiki article on this topic, the appropriate comparison for the investing side of the equation is a bond investment with a similar risk. Given the low yields currently and the numbers being discussed here (2.875%/1.81%), this would point to paying off the mortgage being the better deal no matter what. What 30-year (or 25, as the case may be) risk-free bond yields 1.81% in today's market?
This is actually close to the yield on Treasuries. Vanguard's EDV, which holds zero-coupon Treasuries with a 25-year duration, yields 1.59%. Thus, if you aren't maxing out your IRA, you will essentially break even holding EDV in your IRA rather than paying down your mortgage. And retaining the optionality is worth enough that I wouldn't pay down under those conditions; you can refinance your mortgage if rates fall, while the Treasury cannot refinance its bonds. (I don't recommend buying this fund; I am only using it for a fair comparison.)

But even if you are maxing out, you may not want to pay down a deductible mortgage for a 1.81% return. Vanguard Long-Term Tax-Exempt, which holds high-quality municipal bonds, yields 1.38% on Admiral shares. It does have some credit risk, but it has much less interest-rate risk than a 25-year mortgage, with a current duration of 6 years. (The duration will increase somewhat if rates rise, as many munis are callable).

(edited to fix quoting)
Last edited by grabiner on Mon Dec 28, 2020 7:51 pm, edited 1 time in total.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by abc132 »

I would open up an investment account and pay extra on the monthly mortgage payment (assuming you can actually pay it off early without penalty), with at least as much money going to the investment account as paying extra on the mortgage. When you end up with enough to pay the house off completely, and without tax consequences, go ahead and do so. This helps to balance your desire to have the house paid off with also meeting investing goals.
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Re: Pay Off Our Mortgage or Invest Heavily?

Post by jmann2380 »

A lot of advice here is missing something else that is tangible... simplifying your life. I may be bias since I own a business and have complications there, but with my personal finances I want as few as payments as possible and as little to worry about as possible. Paying off my mortgage was working towards that.
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