Paying off mortgage vs. investment -- cap gains consideration

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ryman554
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Paying off mortgage vs. investment -- cap gains consideration

Post by ryman554 »

I have a decision to make.

Almost 8 years ago, purchased a house in a HCOL with a 625k 3.5% 30 year mortgage. Good low rate at the time. Made the conscious decision to invest my extra savings (after all tax-advantaged investing) in taxable vs. paying down the mortgage. Paying down would do nothing for the cash flow (which was never really in jeopardy), but I promised myself I would pay it off once I could, partially because my wife is very conservative with respect to investing/debt, partially because I really emotionally like the idea of not having a mortgage vis-a-vis having the flexibility of renting without the cost (property taxes/maintenance aside).

Fast forward to today where I have about $500k remaining on a refinanced 2.75% mortgage. My taxable account is nearing $600k, but I've dithered paying it off because a) I still want some semblance of second-tier emergency fund ($50k in taxable) and b) I have to account for capital gains taxes.

The time has come to see if I renege on the promise 8 years ago, and I am tending to do so. I'm not sure it feels *as good* to "be able to" pay off the mortgage vs. actually doing it, but I am also sure I'm going to fee like a chump if the market tanks and I can't do it anymore. That being said, over 5 years, I expect to significantly out earn the mortgage "cost" (I would only need to average 2.75% nominal per annum investing to cover the interest). I would need about a 4% CAGR to offset the entire mortgage cashflow. Definitely probable historically, but not certain.

Why five years? I expect to be moving on in about that time. And I have a *ton* of equity in the house (on paper!) due to price appreciation.

And then there is that little detail about capital gains tax -- at 15% fed, 10% state + whatever NIIT, it's a 25% hit on my gain, which is about 40% of my total portfolio. So, currently, the cap gains hit is about $60k or so.

Summary:
Mortgage = $500k @2.75%. ~$25k/year payment. ~$14k yearly of interest.
Taxable = $600k with about $250k in gains = about $60k in estimated taxes. (invested 100% in equities, 80/20 overall with bonds in the 401(k))
Look to move in about 4-5 years.

Mathematically -- what calculation should I do to see the damage in paying off the house?
bradpevans
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by bradpevans »

For me personally, there’s no way I would incur that much taxes to pay off a secure debt at such a low interest rate.

If you did pay it off, what would you do with the cash flow you are currently using to pay the standard monthly mortgage loan amount? If you’re going to put that money right back in the stock market, and you can see the virtue of leaving your other money in the stock market and just paying the monthly amount
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Toons
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by Toons »

Don't overthink it
Throw 100k at the mortgage.
See how it feels to being just a little closer
To having "no mortgage".
I can' even remember what the rate was when I paid off our 1st home.
I wasn't concerned with numbers.
I just wanted to be mentally
"Unchained"
:wink:
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
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Watty
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by Watty »

ryman554 wrote: Sun Jul 25, 2021 2:34 pm And then there is that little detail about capital gains tax -- at 15% fed, 10% state + whatever NIIT, it's a 25% hit on my gain, which is about 40% of my total portfolio. So, currently, the cap gains hit is about $60k or so.
Two things to consider.

1) Can you figure out some scenario where you would ever pay less in capital gains taxes? If not then it may mainly be a question of when you will pay the capital gains taxes, not if you will pay them sooner or later.

2) If you delay taking the capital gains for a number of years then you may find that the long term capital gains tax rate has increased and you would pay a higher tax rate on the gains.
ryman554 wrote: Sun Jul 25, 2021 2:34 pm Paying down would do nothing for the cash flow (which was never really in jeopardy), but I promised myself I would pay it off once I could.....
One option would be to call your lender to ask if they will "recast your mortgage"(Google this) if you make a large prepayment. They are not required to do this but they usually will for a few hundred dollar fee or even for free. The way this works is if you pay the mortgage down by 50%(or whatever makes sense) then your required monthly payment will be reduced by the same percentage. The interest rate and the length of the loan will stay the same.
ryman554 wrote: Sun Jul 25, 2021 2:34 pm That being said, over 5 years, I expect to significantly out earn the mortgage "cost" (I would only need to average 2.75% nominal per annum investing to cover the interest). I would need about a 4% CAGR to offset the entire mortgage cashflow. Definitely probable historically, but not certain.
Even though interest rates are low investing and earning a higher rate of return is a lot harder than it sounds because you would have sequence of returns risk. Here is a simplistic example of that which I have posted before.
If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To pay off the mortgage at the end of the second year you would need about $96.5K so you would need to gain back $12.5K and another $6,000 for the next years mortgage payments which combined is $18.5K. That would take a 22% return on the remaining $84K to get back to the point where you could pay off the mortgage.

In the past portfolios have declined in roughly one of four or five years depending on the asset allocation. (20 to 25 percent of the time)

https://personal.vanguard.com/us/insigh ... llocations

The sequence of returns risk can also go the other way and you could get lucky and have the first couple of years get good returns that would put you on the path for large gains over the years. There will sometimes be very optimistic projections on just how much better not paying off the mortgage could be but one limiting factor that needs to be considered is that few people actually keep a 30 year mortgage for the full 30 years. It is difficult to put a number on it but many people who own a home will sell it in less than 10 years.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by ApeAttack »

Toons wrote: Sun Jul 25, 2021 4:54 pm Don't overthink it
Throw 100k at the mortgage.
See how it feels to being just a little closer
To having "no mortgage".
I can' even remember what the rate was when I paid off our 1st home.
I wasn't concerned with numbers.
I just wanted to be mentally
"Unchained"
:wink:
Oftentimes in life I'm torn between a couple decent options. In those situations, I usually start with baby steps in some direction and reevaluate afterwards. Throwing a fraction (say, 100k) at the mortgage then reevaluating is a great idea.
May all your index funds gain +0.5% today.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by grabiner »

ryman554 wrote: Sun Jul 25, 2021 2:34 pm I That being said, over 5 years, I expect to significantly out earn the mortgage "cost" (I would only need to average 2.75% nominal per annum investing to cover the interest).

Mortgage = $500k @2.75%. ~$25k/year payment. ~$14k yearly of interest.
Taxable = $600k with about $250k in gains = about $60k in estimated taxes. (invested 100% in equities, 80/20 overall with bonds in the 401(k))
BLUF: The tax cost is enough that I wouldn't pay the mortgage off. If you have any shares with small capital gains, it may be worth selling those shares to pay the mortgage down.

I had a similar decision to make in 2019: Finally considering paying off my mortgage I decided not to pay off the mortgage in 2019, then paid it off in 2020 when the capital gain went away; see this later post near the end of the thread

One difference between your situation and mine is that you are planning to move in 4-5 years, and thus any prepayment has that duration. I had nine years left on my mortgage, so paying it off had a duration of 4.5 years, but paying it down slightly had a duration of 9 years and was thus less attractive. Thus it made sense for me to either pay it all off (or almost all; in February 2020, I paid down from nine years to one, and paid off the last year in April 2020), or not to pay it down. It may make sense for you to pay down as much as you can for only a small capital gain.

Since you have bonds in the 401(k), you would expect to significantly out earn the bonds if you sold those bonds to buy stocks/ Presumably, you aren't doing this because of your risk tolerance. Therefore, it isn't fair to compare the mortgage return to the stock-market return, as this changes your risk.

The fair comparison is to pay down your mortgage without changing your risk level. That is, you can sell taxable stock, and move an equal amount from bonds to stock in your 401(k). You will gain or lose the same number of dollars if the stock market booms or crashes. (This is exactly what I did, and since I did the payoff near the COVID market bottom, that was important; I cleared the mortgage in a bear market and still got the same benefit from the recovery.)

But the comparison would not be between your mortgage rate and the bond yield in the 401(k), since moving stock from taxable to tax-advantaged gives a tax benefit. Therefore, I prefer making the comparison with a low-risk municipal-bond fund, or the after-tax return on a taxable bond fund; in either case, use a fund with the same duration as the prepayment. Therefore, the rate to use for comparison is the 0.70% yield on Admiral shares of Vanguard Intermediate-Term Tax-Exempt. Total Bond Market Index has slightly too long a duration; an equal mix of Intermediate-Term Bond Index Index and Short-Term Bond Index, which has about the right duration, yields 0.95%, which is about the same after tax in a 24% bracket. (I used Intermediate-Term Tax-Exempt for my comparison.)

Now, compare the difference between the after-tax mortgage rate and the muni yield. Your after-tax return depends on how much of the interest is deductible, which depends primarily on how much you contribute to charity. If you pay the mortgage down, you pay down deductible interest before non-deductible interest. (My mortgage was entirely deductible; I donate enough to charity that I itemize even without a mortgage.)

The after-tax return is then reduced by the annualized cost of any capital gains. If the capital-gains tax is 10% of the paydown amount, and these are shares that you would otherwise never sell (leaving them to your heirs or charity), the cost is 2% annualized over five years. If these are shares that you will sell in retirement when they are taxed at a lower rate (for example, you will retire in a state with no income tax), you lost most of the cost by selling now, as you lose a lot of deferral and pay more dollars now. (I counted most of the cost, because I am still working. If I didn't sell to pay off my mortgage, I would likely be buying more stock in future years, and would sell that stock first. The stock that I would sell to pay off the mortgage would likely be sold many years later, with the benefit of deferring the tax.)
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by shess »

I paid off my mortgage way early, so normally I'd make a pay-down argument, but I don't think I'd do it in a situation where I was taking unforced capital gains to do it. In my case, I had a concentrated employer-stock position which needed to be diversified, so I was realizing those gains regardless, which left the question of where to put the resulting cash. I decided that the mortgage was a better target than the market. [I was wrong - putting it into the market would have left me with 2x the mortgage amount left over after paying the mortgage. Then again, leaving it in the employer stock would have left me with 6x the mortgage amount, so you win some, you lose some :-).]

That said, I think I would consider where to place fresh cashflow. For instance, I'd probably prefer to pump additional funds into the mortgage rather than any more taxable investments. Likewise with any taxable dividends you get, ship those right over to the mortgage rather than reinvesting them. I wouldn't cut back on 401k contributions at all, though. I'd also look at my various positions and see if any specific lots might be liquidated at a low tax cost.

Personally, even if I could only put an extra $100/month towards the mortgage, I'd do that in preference to pumping more into the market. $100/mo doesn't sound like much, but it takes years off the tail end of the mortgage.

I'm not entirely sure if moving in 4-5 years really puts the overall project into doubt, it just gives you some optionality on various events. But when you move, presumably your new place will be somewhat comparable to the current place's value, and your new mortgage will be somewhat comparable to the current mortgage, in which case it's a wash. An interesting case is if you're planning to move to a lower COL area. In that case, you might find that your existing equity might move from leaving you with a 50% loan-to-value ratio to more like an 80% loan-to-value ratio - or your current equity might even exceed the value of your next place. In that case, it would be kinda silly to pay capital gains taxes to add to your equity today only to have it returned to you in 4-5 years and then have to figure out where to invest it. Better to just leave it invested.
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ryman554
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by ryman554 »

Thank you all for the replies so far.

1. When I move, it's going to be a LCOL area and a *much* cheaper house (with no mortgage at all). Also likely an "early retirement" and/or low-wage situation, so income will come way down.
2. Grabiner put it in good perspective that I should consider the duration of the cost. Silly me. In this case, it truly is about 2-2.5 years.
3. If/when I pay this off, I'm putting all mortgage payments back into the taxable account, as per my imaginary IPS.
4. I tax-loss-harvested as much of my taxable account as I could last year -- now most of my taxable lots are in the 50%+ growth category. Great for the recovery, sub-optimal for this case.
5. Watty, I can't recast the mortgage since I refinanced last year. As per the OP, I do not pay down -- I made the decision (I am happy with) to invest extra cash into a taxable account vs. putting additional principal to the mortgage.

I'm hearing critique about what's the unforced capital gains: in this case it's $60k, and much of it really is a timing issue... In future years (5+ years hence), some/most could be used at a significantly lower rate (40% less by moving to a no-tax state, perhaps some from lower fed tax brackets, perhaps delayed in perpetuity because of the equity unlocked by selling existing house). One might say that I would not incur that $60k hit if I didn't pay off the mortgage at all. Answer from these folks, "likely not a good idea."

I'm hearing one or two of you indicate I should do a partial paydown -- send extra cash/dividends to mortgage vs. continually investing in taxable. I don't think I'm going to do that. Over the "long term" (5+ years), that's going to be a odds-on losing proposition mathematically. I don't care about the tail end of the mortgage, since I'm not going to see it, anyhow. I'd rather keep the money liquid-ish. Not necessarily for emergency use, but for options.

One or two said "pay it off, it will feel good". Thanks, but I already know that feeling. 10 years ago I *was* mortgage free; it allowed me flexibility to move into a HCOL and obtain a house (with a anchor of a mortgage) instead of being a renter today. I do like the feeling. I appreciate the flexibility. But is that flexibility worth $60k? Let's focus on the math, instead.

Gonna think about it some more.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by Watty »

ryman554 wrote: Mon Jul 26, 2021 8:16 am $500k remaining on a refinanced 2.75% mortgage.

So, currently, the cap gains hit is about $60k or so.

In future years (5+ years hence), some/most could be used at a significantly lower rate (40% less by moving to a no-tax state,
For perspective

40% of $60k is $24K that might save if your actually move in 5+ years but that is not certain.

With a $500K mortgage you would pay $13,750 in interest next year so over five years you would pay around $65K in interest on the mortgage if you not pay it off.

You would also have 72 mortgage payments of maybe $2000 over those five years which would total somewhere around $144K.

Your $600 in investments could also go up or down a lot in five years too if you do not pay off the mortgage.

Given all the other amounts involved possibly saving $24K in five years is a very minor factor. If you were planning on moving next year that might be more important.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by MoonOrb »

If you're going to move in five years to a place where you don't need a mortgage, you will be paying an awful lot to accelerate this feeling of being mortgage free by just five years.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by jsapiandante »

bradpevans wrote: Sun Jul 25, 2021 4:43 pm For me personally, there’s no way I would incur that much taxes to pay off a secure debt at such a low interest rate.

If you did pay it off, what would you do with the cash flow you are currently using to pay the standard monthly mortgage loan amount? If you’re going to put that money right back in the stock market, and you can see the virtue of leaving your other money in the stock market and just paying the monthly amount
This. I also have a large mortgage balance (~$500k @2.325% 30 years) and have enough in my taxable now to pay it off. Problem is I have over $200k in capital gains. If your plan was to pay it all off then with your newfound cash flow, put it back in the market, I'd rather just keep the amount invested and pay the monthly mortgage with the taxable account.

I look at this way, why would I move a large amount of liquid asset to an illiquid asset? Even if the market crashed at 50% and stayed there for a while, I can still survive for several years just off my taxable account. I wouldn't be able to access the equity of my home quite easily during a downturn.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by harikaried »

ryman554 wrote: Sun Jul 25, 2021 2:34 pmWhy five years? I expect to be moving on in about that time. And I have a *ton* of equity in the house (on paper!) due to price appreciation.

And then there is that little detail about capital gains tax -- at 15% fed, 10% state + whatever NIIT, it's a 25% hit on my gain
Are you moving to a state without capital gains tax? Would you be selling stocks anyway to purchase a new house?

If you would want to sell stocks for a new house, then you would need to pay capital gains taxes anyway, so it's not a direct comparison between not incurring capital gains tax vs the 28.8%. However, if you can save on 10% state tax, it could be worthwhile to take out a mortgage for a new house while still a resident of the current state to then realize gains at a more favorable time.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by grabiner »

ryman554 wrote: Mon Jul 26, 2021 8:16 am 2. Grabiner put it in good perspective that I should consider the duration of the cost. Silly me. In this case, it truly is about 2-2.5 years.
The duration is close to 5 years, even if you pay it off. You get a small amount back every month, but most of the money comes back in five years when you sell the house and are forced to pay off the mortgage at that time.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by bradpevans »

For me, the time frame isn’t so much the mortgage but rather whenever you actually use the long term investment

In one scenario you pay M and invest S till the mortgage is done, then M+S goes in to the market

Or, you put M+S into the mortgage, pay it off sooner then M+S into the market

In the long run (as in when you take money out), I think the former beats the latter
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by ryman554 »

Watty wrote: Mon Jul 26, 2021 8:54 am
ryman554 wrote: Mon Jul 26, 2021 8:16 am $500k remaining on a refinanced 2.75% mortgage.

So, currently, the cap gains hit is about $60k or so.

In future years (5+ years hence), some/most could be used at a significantly lower rate (40% less by moving to a no-tax state,
For perspective

40% of $60k is $24K that might save if your actually move in 5+ years but that is not certain.

With a $500K mortgage you would pay $13,750 in interest next year so over five years you would pay around $65K in interest on the mortgage if you not pay it off.

You would also have 72 mortgage payments of maybe $2000 over those five years which would total somewhere around $144K.

Your $600 in investments could also go up or down a lot in five years too if you do not pay off the mortgage.

Given all the other amounts involved possibly saving $24K in five years is a very minor factor. If you were planning on moving next year that might be more important.
This particular post gave me pause, since I had almost decided to go the "not pay it off route". That's why I come here -- to hear dissenting views.

In this case, if I move, then *all* of the $60k cap gains is being saved (or, more precisely, deferred a lot longer) since I no longer need to liquidate the taxable account.

As I look at it, we're comparing "spending" $60k in taxes "today" vs. "spending" $65k or so in "interest" over five years. To first approximation, that's a wash, but it should point out that the cap gains hit is on the order of the interest -- just that one is overt and one drips at you over time.

I'm going to ignore the principal part since I get that back anyhow and cash flow is not a concern today. I invest multiples of my mortage payment every month. It *is* a concern that I am not using the $1k/month more efficiently (home equity vs. investments), but if that was an overriding concern, I wouldn't be moving $500k all at once into the same home equity black hole.

So, it all boils down to -- is it better for me to have the $500k in the market or in the house for five years? I suppose I answered that question to myself a long time ago by making the decision not to prepay and instead invest extra funds into a taxable account. I can guarantee that if I put it into the house, it's going to earn zero, except the interest savings that is just about the same as the capital gains hit I would incur. Over five years, it is *statistically significantly likely* (can't find the distributions, but I seem to recall that there have been no 10 year periods in history that the overall CAGR was less than 0, and there have only been very few 5 year such periods).

I think I'll retain the option to pay off the house, but not yet pull the trigger.

Thanks for all the advice.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by psychoslowmatic »

I’d consider refinancing to a 0-costs 15 year at about 2% and cash flow whatever extra you have as you go. I wouldn’t pay taxes now and to reinvest in 5 years.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by Watty »

ryman554 wrote: Thu Jul 29, 2021 11:23 am I can guarantee that if I put it into the house, it's going to earn zero, except the interest savings that is just about the same as the capital gains hit I would incur.
Somewhere in your calculations you also need to factor in that if you paid off the mortgage then you would not have a mortgage payment which you said was about $25K a year. If you save that freed up mortgage payment for five years that is $125k plus any earning.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by TheHiker »

I would not sell the investments to pay off the mortgage. You will pay more in taxes than you save on interest over 4 years.
What I did was reduce my monthly investment contributions to accelerate the mortgage payments.
Ended up paying off the mortgage without incurring cap gains. I'll likely be in a 0% cap gains bracket when I retire so it makes sense to delay realizing the gains.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by harikaried »

ryman554 wrote: Thu Jul 29, 2021 11:23 amis it better for me to have the $500k in the market or in the house for five years? I suppose I answered that question to myself a long time ago by making the decision not to prepay and instead invest extra funds into a taxable account
If the goal is to maximize money, then it does seem likely leveraging with the mortgage to invest more money in stocks will be better. It looks like your 20% bond allocation is at least $120k, which wouldn't cover paying off your mortgage, so you effectively are investing more in stocks than a 100/0 asset allocation. (Unclear how much money is in your 401k, but if bonds totals over your mortgage, you effectively aren't leveraged but instead relatively inefficient to pay mortgage interest to invest in bonds that might yield less.)

It seems like the home value should be over $900k assuming an average 5% appreciation over the last 8 years, so theoretically you could have cash-out refinanced to have a $750k mortgage instead of the current $500k. Your taxable account could have invested the extra $250k even at the same 80/20 asset allocation, and similar reasoning from above, it would likely outperform the additional mortgage interest.

As you mentioned, you made a decision to not prepay to invest extra funds in a taxable account, so why not even more? At the end of the day, there's people who think debt/leverage should be minimized while others think using other people's money is a great way to make more money, and there will be plenty of people who need to find their personal level of likely somewhere in between.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by alpinegoat »

I'll offer a different view. I had a similar mortgage amount ($600k) in 2015 at 3.625%, 30 years. Over these 6 years, rather than making post tax investments, I have put extra towards the principal, so now the balance is about $180k. It's close enough to see the finish line. I have to say, I have gained a lot of satisfaction and am proud of the effort and progress on it and the growing fraction of house owned. Each month, financial freedom feels nearer and post-mortgage lifestyle and goals become more imaginable. Of course it is true, hindsight being 20/20, that the same amount of pre-payment invested in S&P500 would have been larger even after capital gains taxes are paid. You seem purely focused on a mathematical argument and somewhat ignoring risk, but I just wanted to offer a counter example from someone with no regrets.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by wwtraveler »

For the non-payoff scenario you could consider just splitting the money each month in some way to make you feel like you are burning the candle on both ends. To me that's a bit of psychological fix but it also is a real hedge too. If the S&P corrects in 2 years by 25% and you go "ah!" then maybe this technique will make you feel better?

Loan + Principal Reduction = .5x (or whatever factor you want) of the money you plan to invest.

That way you are locking in a portion of your investment into a guaranteed return (principal reduction) and the rest can live happily in the market.

If you run the scenarios and use some moderate numbers, let's say it's "just" an 8% rate on S&P for 5 years you'll see the investment opp you give up by splitting the investment and principal reduction is unlikely to be a life changing return.

IMO we do these financial optimizations and it causes complexity. You can get into all kinds of back and forth if complexity and optimization is the right thing for you and your loved ones that may have to take over the situation if something were to happen to you (don't forget that part!) The bigger thing to address though is does the optimization lead to a few dollars and cents or is it a life changing money optimization?

I'm not saying to be vanilla and accept non optimal results but sometimes the complexity + effort are truly not worth the minuscule reward.

For fun I'm rattling off some options and ranking them by effort & complexity.

1) Pay payments only and all the rest gets invested. Complexity/Effort: LOW

2) Split the difference and hedge with some principal reduction. Complexity/Effort: Relatively low as just about everyone has as decent online mortgage portal that can add principal reductions either separately or automatically.

3) Payoff house. Complexity/Effort: MEDIUM. Why? Because there's some cost to this too due to tax implications and related advice you may pay for. There's some insignificant recording and payoff costs too and this may trigger you to do other stuff like evaluating how much insurance you'd like on the house (maybe more?) and how you hold title (trust?).

4) Refinance to lower rate. Complexity/Effort: HIGH Why? You probably have real closing costs and fees and other administrative hassles. It also pushes you to then go all in on #1 and for such a short period is it worth that complexity?

5) Payoff house, get HELOC and then invest the HELOC into taxable account. I don't think anyone mentioned this one. Complexity/Effort: HIGH! I put this here as an example of something more complex. This to me is an example of something you probably wouldn't want to leave your family with if something were to happen to you.

ryman554 wrote: Thu Jul 29, 2021 11:23 am
Watty wrote: Mon Jul 26, 2021 8:54 am
ryman554 wrote: Mon Jul 26, 2021 8:16 am $500k remaining on a refinanced 2.75% mortgage.

So, currently, the cap gains hit is about $60k or so.

In future years (5+ years hence), some/most could be used at a significantly lower rate (40% less by moving to a no-tax state,
For perspective

40% of $60k is $24K that might save if your actually move in 5+ years but that is not certain.

With a $500K mortgage you would pay $13,750 in interest next year so over five years you would pay around $65K in interest on the mortgage if you not pay it off.

You would also have 72 mortgage payments of maybe $2000 over those five years which would total somewhere around $144K.

Your $600 in investments could also go up or down a lot in five years too if you do not pay off the mortgage.

Given all the other amounts involved possibly saving $24K in five years is a very minor factor. If you were planning on moving next year that might be more important.
This particular post gave me pause, since I had almost decided to go the "not pay it off route". That's why I come here -- to hear dissenting views.

In this case, if I move, then *all* of the $60k cap gains is being saved (or, more precisely, deferred a lot longer) since I no longer need to liquidate the taxable account.

As I look at it, we're comparing "spending" $60k in taxes "today" vs. "spending" $65k or so in "interest" over five years. To first approximation, that's a wash, but it should point out that the cap gains hit is on the order of the interest -- just that one is overt and one drips at you over time.

I'm going to ignore the principal part since I get that back anyhow and cash flow is not a concern today. I invest multiples of my mortage payment every month. It *is* a concern that I am not using the $1k/month more efficiently (home equity vs. investments), but if that was an overriding concern, I wouldn't be moving $500k all at once into the same home equity black hole.

So, it all boils down to -- is it better for me to have the $500k in the market or in the house for five years? I suppose I answered that question to myself a long time ago by making the decision not to prepay and instead invest extra funds into a taxable account. I can guarantee that if I put it into the house, it's going to earn zero, except the interest savings that is just about the same as the capital gains hit I would incur. Over five years, it is *statistically significantly likely* (can't find the distributions, but I seem to recall that there have been no 10 year periods in history that the overall CAGR was less than 0, and there have only been very few 5 year such periods).

I think I'll retain the option to pay off the house, but not yet pull the trigger.

Thanks for all the advice.
mnnice
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by mnnice »

One thing to keep in mind is that stocks and home prices sometimes work in tandem and sometimes hike their own hikes. They both can go up or down so the real right answer requires clairvoyance. :|


If your tentative life plan is to live in a cheaper place and make less money I would probably hold off on realizing the gains. They might be better suited to being sold later to fund normal life stuff.

Also what would be your capital gains on your house? Is it anywhere near the limits? Might be another piece of the puzzle or not?
shess
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by shess »

ryman554 wrote: Thu Jul 29, 2021 11:23 am As I look at it, we're comparing "spending" $60k in taxes "today" vs. "spending" $65k or so in "interest" over five years. To first approximation, that's a wash, but it should point out that the cap gains hit is on the order of the interest -- just that one is overt and one drips at you over time.
Maybe I'm misunderstanding your point, but the $65k in interests costs is real money which you have to come up with, whereas the $60k in taxes is just pulling forward a payment you're already (somewhat) liable for. You can avoid that tax hit by dying and passing the stocks on to your heirs with a stepped-up basis, or by gifting the shares to charity, but in all likelihood you will at some point liquidate some of those shares to fund something or other, and you'll pay taxes on that.

I mean, don't get me wrong, as a general rule, you're better off liquidating and paying those taxes later rather than earlier, for sure.

Also, you keep coming back to wanting a mathematical calculation to show which choice to make. Unfortunately, the math is straight-forward - if you assume the remainder of your mortgage term will be like the past 30 years, then there's basically no way paying down a 2.75% mortgage will come out ahead of holding out for more gains. I've made 10.5% IRR over the past 30 years, 10.5% > 2.75%, QED. Unfortunately, math can't tell you if the future will be the same as the past, you have to make a bunch of estimates and assumptions. Personally, given the past year and a half of how the world has gone and how the market has performed, I'd have no qualms at all about putting spare cashflow towards my mortgage rather than towards additional investment in a taxable account. In fact, I have no mortgage and once a week have to talk myself down from selling a bit, but all the plans I wrote down years ago sum up to "Now is not the time."
harikaried
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by harikaried »

ryman554 wrote: Mon Jul 26, 2021 8:16 amWhen I move, it's going to be a LCOL area and a *much* cheaper house (with no mortgage at all). Also likely an "early retirement" and/or low-wage situation, so income will come way down.
Even if you could pay for the new house with the equity from selling the current house, why not get a mortgage hopefully at a good rate and invest the rest? Depending on how quickly your income goes down, you could then realize long-term gains at 0%.
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ryman554
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by ryman554 »

harikaried wrote: Fri Jul 30, 2021 4:37 pm
ryman554 wrote: Mon Jul 26, 2021 8:16 amWhen I move, it's going to be a LCOL area and a *much* cheaper house (with no mortgage at all). Also likely an "early retirement" and/or low-wage situation, so income will come way down.
Even if you could pay for the new house with the equity from selling the current house, why not get a mortgage hopefully at a good rate and invest the rest? Depending on how quickly your income goes down, you could then realize long-term gains at 0%.
Because I don't like borrowing money if I don't have to.

I was "forced" into a mortgage ($625k)if I wanted to live in a house. The rent vs buy was a clear win for buy in 2011. Interest rates were low, housing prices were "low" and rents were going up
I do not regret that decision.

Not paying down on a mortgage vs investing is different -- even mathematically -- than borrowing to invest. The former does nothing to reduce monthly cash flow, so I am still at risk of defaulting on mortgage if things go bad. The latter puts a house at risk (admittedly quite low) for sake of increased wealth I made the choice to invest and intended to pay the debt off in full. I have since reevaluated that decision, and am ok with that. See below.

It's also not the same as not paying it off today, since it would require an unforced tax hit (today) vs. probable reduction or elimination in the future. In this case the tax hit is roughly equivalent to the interest coat, so the math says it's probably better to keep the mortgage

So, while I don't like debt and won't go out of my way to get into it, it's not sound to get rid of it at this stage.

I may yet get to 0% ltcg. Got a lot of tIRA $$ to work through. But even if I get to. A low tax state and utilize taxable, it's likely *some of it* will be at 0%. Or it may all end up to my kids. I'll trundle over to iORP (?) and figure out how to balance all that when it becomes more clear.
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by RyeBourbon »

psychoslowmatic wrote: Thu Jul 29, 2021 11:43 am I’d consider refinancing to a 0-costs 15 year at about 2% and cash flow whatever extra you have as you go. I wouldn’t pay taxes now and to reinvest in 5 years.
+1
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by ryman554 »

psychoslowmatic wrote: Thu Jul 29, 2021 11:43 am I’d consider refinancing to a 0-costs 15 year at about 2% and cash flow whatever extra you have as you go. I wouldn’t pay taxes now and to reinvest in 5 years.
And, as an update, that is exactly what I did.

Went with a no-cost 1.99% 15 year loan, increases P&I by $1200/month. Could have went to 1.875 with a 10-year, but crimps the cash flow just a wee bit too much for no significant change in interest rate.

Thanks again.
psychoslowmatic
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Re: Paying off mortgage vs. investment -- cap gains consideration

Post by psychoslowmatic »

Thanks for updating, glad I was able to give some good advice. I agree the cash flow hit isn’t worth 1/8 lower interest.
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