Use taxable account to pay off mortgage early?

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321jer
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Use taxable account to pay off mortgage early?

Post by 321jer »

I'd love some help checking my math on paying off my mortgage early.

I understand the downsides to paying it of early, but still want to. I'm wondering if using a taxable account to save could help reduce some of the downsides and still pay it off early. I'm wondering if I'm crunching numbers correctly based on the assumptions given.

Mortgage $220k
15 years @ 2.25%
Current Principle Payment - $1441

I have $250 extra that I can put towards the mortgage.

NPER function says that that I'd pay that off in 12.5ish years and save $7k

If instead, I invested it and it grew at 5% for 12.5 years, FV function says it'd be worth $51k ($37k principle, $14k growth)

After longterm capital gains tax $2100, my math says I'd still pay it off at 12.5 years and have $7k left over.

Is my math correct based on these assumptions?

(I'm also open to opinions about whether it is a good idea or not, but am primarily interested in checking the math).

Thanks everyone.
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corn18
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Re: Use taxable account to pay off mortgage early?

Post by corn18 »

A $220k mortgage @ 2.25% fixed rate has a NPV of $220k if you assume inflation is 2.25%. Enough lecturing. I want to pay off my $500k 30 year 2.25% fixed rate mortgage, too. I haven't, but I think about it a lot.

I would invest the $250 / month and then pay off the mortgage when the balance gets big enough to do so. You maintain liquidity. Paying extra every month is the worst of both worlds.
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Watty
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Re: Use taxable account to pay off mortgage early?

Post by Watty »

321jer wrote: Thu Jan 20, 2022 9:13 am Use taxable account to pay off mortgage early?
.....
I have $250 extra that I can put towards the mortgage.
For clarification is that $250 a month that you can pay down the mortgage, or $250K that you can use to pay off the mortgage?

There is a huge difference in paying a mortgage down and paying it off.

I am a generally a big fan of paying a mortgage off but if you would just be paying it down then I would suggest you save and invest the money instead until you have 10 or 20 percent of the balance. You can then check with your lender to see if they will "recast your mortgage"(Google this). They are not required to but they usually will for a couple of hundred dollar fee or even for free. The way this works is that if you pay your loan balance down by 10%(or whatever makes sense) then your required mortgage payment will go down by the same percentage. The length of the loan and interest rate stay the same. If you just send them extra money each month then that just shortens the length of the loan. With a recast having the lower required mortgage payment could be very important if something happens like you are laid off, disabled, or interest rates go up a lot.
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321jer
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Re: Use taxable account to pay off mortgage early?

Post by 321jer »

Yes $250.00 extra each month to pay toward principle.

I've never heard of recasting. That's fascinating and overcomes one of the issues with paying extra. The mortgage can be paid off early but it doesn't change the monthly obligation till its paid in full.

@corn18 don't stop lecturing understanding the numbers is what I'm hoping to do. I've used NPV to understand bond valuations but don't know how to use it to understand paying off a mortgage.
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Re: Use taxable account to pay off mortgage early?

Post by vas »

Another recommendation to invest the $250 rather than pay it toward the mortgage. This provides more flexibility and has a good chance of out performing the monthly payments. You can always pay a lump sum toward the mortgage if you like and as someone mentioned above recasting may be available from your lender.
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Admiral
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Re: Use taxable account to pay off mortgage early?

Post by Admiral »

Unless you're buying taxable bonds with your spare money, do not prepay a 2.25% mortgage. Invest.

Have you looked at inflation lately?

And, grammar police alert: it's principal, not principle.
remomnyc
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Re: Use taxable account to pay off mortgage early?

Post by remomnyc »

Tritto on invest the extra cash. Your mortgage rate is currently less than inflation. We could pay off our mortgage in full but we leave it in place because it preserves liquidity and the interest rate is less than inflation.
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Re: Use taxable account to pay off mortgage early?

Post by grabiner »

See Paying down loans versus investing on the wiki.

If you are only paying the mortgage down, then paying gives you a 15-year return of 2.25%, which isn't very good. Vanguard Long-Term Bond Index is a low-risk fund with a 16-year duration, currently yielding 2.72%. If you are in a 24% tax bracket, that would be 2.05% after tax, which probably isn't worth the loss of liquidity and optionality. Thus, rather than paying down the mortgage, you could invest in that bond fund and decide whether to pay it down later depending on what happens to rates, with little change in risk You could also invest in a different bond fund, trading off return for risk; this fund makes the closest to a fair comparison./

If you can pay it off, or can pay down enough that you can recast, then the prepayment has a 7-year duration, since it eliminates payments every month for the next 15 years. Now the comparison is to Total Bond Market Index at a 1.70% yield, which would be 1.29% after tax, or to Vanguard Long-Term Tax-Exempt at 1.28% tax-free if you are in a higher tax bracket. This is worth prepaying if you don't need the liquidity, as you come out ahead by 1% per year at the same risk.

(I made a similar decision. In 2019, it wasn't worth paying down my 9-year mortgage because that payment would have had a 9-year duration, and it wasn't worth paying off the mortgage because I would have to sell stocks for a significant capital gain. In 2020, when the capital gain went away, I was able to pay off the mortgage with a 4.5-year duration. And while I sold stocks, I didn't change my stock allocation; I sold stocks for the payoff, then moved an equal amount in my employer plan from bonds to stocks.)
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Re: Use taxable account to pay off mortgage early?

Post by Eurookat »

I'm in the same boat. If the idea is to invest the money, what type of fund is idea? ETFs?
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JoeRetire
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Re: Use taxable account to pay off mortgage early?

Post by JoeRetire »

321jer wrote: Thu Jan 20, 2022 9:13 am Mortgage $220k
15 years @ 2.25%
Current Principle Payment - $1441

If instead, I invested it and it grew at 5% for 12.5 years, FV function says it'd be worth $51k ($37k principle, $14k growth)

(I'm also open to opinions about whether it is a good idea or not, but am primarily interested in checking the math).
So you want to pay off a 2.25% rate mortgage by selling investments that you assume will grow at 5%. And you still want to do it.

But you are asking for opinions about whether it is a good idea or not?
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Re: Use taxable account to pay off mortgage early?

Post by samsoes »

JoeRetire wrote: Fri Jan 21, 2022 6:12 am
321jer wrote: Thu Jan 20, 2022 9:13 am Mortgage $220k
15 years @ 2.25%
Current Principle Payment - $1441

If instead, I invested it and it grew at 5% for 12.5 years, FV function says it'd be worth $51k ($37k principle, $14k growth)

(I'm also open to opinions about whether it is a good idea or not, but am primarily interested in checking the math).
So you want to pay off a 2.25% rate mortgage by selling investments that you assume will grow at 5%. And you still want to do it.

But you are asking for opinions about whether it is a good idea or not?
2.25% morrgage rate is guaranteed, 5% annual investment returns are not.

Furthermore, there is a huge peace of mind factor in paying off a mortgage, regardless of the potential forfeited returns. This is especially true if one's employment situation is precarious or one thinks another 2008-2009 market is forthcoming accompanied by a job loss.

I paid my mortgage off in 2014, and it was probably the best financial decision I ever made. I sleep much better at night.
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corn18
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Re: Use taxable account to pay off mortgage early?

Post by corn18 »

samsoes wrote: Fri Jan 21, 2022 6:27 am
JoeRetire wrote: Fri Jan 21, 2022 6:12 am
321jer wrote: Thu Jan 20, 2022 9:13 am Mortgage $220k
15 years @ 2.25%
Current Principle Payment - $1441

If instead, I invested it and it grew at 5% for 12.5 years, FV function says it'd be worth $51k ($37k principle, $14k growth)

(I'm also open to opinions about whether it is a good idea or not, but am primarily interested in checking the math).
So you want to pay off a 2.25% rate mortgage by selling investments that you assume will grow at 5%. And you still want to do it.

But you are asking for opinions about whether it is a good idea or not?
2.25% morrgage rate is guaranteed, 5% annual investment returns are not.

Furthermore, there is a huge peace of mind factor in paying off a mortgage, regardless of the potential forfeited returns. This is especially true if one's employment situation is precarious or one thinks another 2008-2009 market is forthcoming.

I paid my mortgage off in 2014, and it was probably the best financial decision I ever made. I sleep much better at night.
0% real interest rate is highly likely. Negative real rate is a good possibility. I'm getting paid this year to carry my 2.25% mortgage and I don't need to make a dime in the market.
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Re: Use taxable account to pay off mortgage early?

Post by KlangFool »

OP,

I only pay down my mortgage when I had reached my financial independent number.

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Re: Use taxable account to pay off mortgage early?

Post by markjk »

OP,

It's more than just the pure investment return comparisons. It's also liquidity. If you keep your money, you have access to it when/if needed. If you pay your house off, you have to run through some hoops to try and get cash back out if it's ever needed.

If rates were back to 4+ %, I think the historical advice of paying it off would still make sense. I'm not a fan of debt but with today's rates on homes, I just don't see the benefit of paying it off assuming you are instead investing the money. Emotionally if it's a goal and you really want to do it, I also don't think it's a bad thing to do. I just don't think it's the best long term financial decision.
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Re: Use taxable account to pay off mortgage early?

Post by Eurookat »

I know this could be said for many occupations but my goal was to pay my 20yr mortgage off in 12yrs. That would be me in my mind 50s. Why? I'm afraid by then I would no longer be employable. I work in a field that is high on ageism (IT) and the last thing I need to worry about is paying for my mortgage and reentering the workforce at the salary I would be making at that time
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Re: Use taxable account to pay off mortgage early?

Post by mbasherp »

If your goal is to pay off and not just pay down the mortgage, I agree it’s best to invest monthly toward your target payoff amount. Then when you get there, you can decide what to do.

I began this approach 6 years ago. I expected it to take 12 years to hit my payoff amount. What I couldn’t have seen coming was that investment returns were far higher than projected AND I was able to refinance 3 times, all the way down to 2.5% on a new 30 year from my original rate of almost 4%. I’m currently 85% of the way there (and could technically stretch and use a few other accounts and my EF to just do it now), but I am no longer leaning toward paying off the mortgage even when I have the money. Perhaps if I reach full financial independence it would be an easy risk off move. But I’m really liking the warm blanket of a taxable account worth several years of expenses!

Importantly though, I am in my 30’s. If I were 20-30 years older, I’d just be done with it.
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Re: Use taxable account to pay off mortgage early?

Post by IntlRetiree »

markjk wrote: Fri Jan 21, 2022 7:04 am OP,

It's more than just the pure investment return comparisons. It's also liquidity. If you keep your money, you have access to it when/if needed. If you pay your house off, you have to run through some hoops to try and get cash back out if it's ever needed.

If rates were back to 4+ %, I think the historical advice of paying it off would still make sense. I'm not a fan of debt but with today's rates on homes, I just don't see the benefit of paying it off assuming you are instead investing the money. Emotionally if it's a goal and you really want to do it, I also don't think it's a bad thing to do. I just don't think it's the best long term financial decision.
I agree. There is a reason there are so many ads on TV for reverse mortgates using actors like Tom Selleck directed towards an older population. Don't get in the position of house rich / cash poor.
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Re: Use taxable account to pay off mortgage early?

Post by Tom_T »

I had six years left on my mortgage at 3.6%, and I refinanced into a ten-year at 2.2%. The monthly payment is $1,000 lower than my old one, and fits into my budget (whether I'm retired or not.) I have money to pay it off, so it's not a peace-of-mind issue. I don't see any pressing need to do so with such a low rate (and thanks to BHers who advised me on this not long ago.) I'd rather have the liquidity right now, especially since I'm 63 and am counting years to retirement on a couple of fingers. The extra money makes it a lot easier for me to max out 401K and Roth, so it makes sense.

Maybe in a few years, if I'm down to a 50K balance, I'd consider paying it off, but I'll likely play it by ear. Honestly, given that my property taxes make up 40% of my monthly payment, I'm always going to have to budget something every month for the house, so it's not like paying off the mortgage removes a huge financial burden. It would free up $12K/year, which isn't life-changing by any means.
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Re: Use taxable account to pay off mortgage early?

Post by JoeRetire »

samsoes wrote: Fri Jan 21, 2022 6:27 am
JoeRetire wrote: Fri Jan 21, 2022 6:12 am
321jer wrote: Thu Jan 20, 2022 9:13 am Mortgage $220k
15 years @ 2.25%
Current Principle Payment - $1441

If instead, I invested it and it grew at 5% for 12.5 years, FV function says it'd be worth $51k ($37k principle, $14k growth)

(I'm also open to opinions about whether it is a good idea or not, but am primarily interested in checking the math).
So you want to pay off a 2.25% rate mortgage by selling investments that you assume will grow at 5%. And you still want to do it.

But you are asking for opinions about whether it is a good idea or not?
2.25% morrgage rate is guaranteed, 5% annual investment returns are not.

Furthermore, there is a huge peace of mind factor in paying off a mortgage, regardless of the potential forfeited returns. This is especially true if one's employment situation is precarious or one thinks another 2008-2009 market is forthcoming accompanied by a job loss.

I paid my mortgage off in 2014, and it was probably the best financial decision I ever made. I sleep much better at night.
The OP is assuming a 5% return over 12.5 years. The OP said nothing about needing a huge piece of mind factor and doesn't mention having problems sleeping at night.
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Re: Use taxable account to pay off mortgage early?

Post by Hyperchicken »

Uncertain employment situation seems like a good case for keeping as much of your money liquid as possible, which means not paying off/down the mortgage.

Not paying mortgage off:

Months of expenses = Liquid assets / (Monthly expenses + Mortgage payment)

Paying mortgage off:

Months of expenses = (Liquid assets - Payoff amount) / Monthly expenses

Which one is greater? The math can go either way depending on the numbers.
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Re: Use taxable account to pay off mortgage early?

Post by vitaflo »

321jer wrote: Thu Jan 20, 2022 9:13 am Mortgage $220k
15 years @ 2.25%

If instead, I invested it and it grew at 5% for 12.5 years
Keep in mind these are not equivalent returns. One is risk free, the other caries a lot more risk which is why it potentially has higher returns. You need to determine the risk you want to take before making decisions such as this.

A better comparison would be paying off your mortgage vs buying 15 year treasuries.
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321jer
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Re: Use taxable account to pay off mortgage early?

Post by 321jer »

Thanks all.

I do want to pay it off early(peace of mind, freedom etc)
But was hoping to avoid the downsides(loss of liquidity, paying with today's dollars vs 2030 dollars, not having a reduced payment until its paid off)

Investing in a taxable account (index funds) seems like a way to achieve the upside of paying off early and minimize the downsides.

I used 5% growth in the taxable account just to run some conservative numbers, and see if it would even be worth it after paying taxes. (I of course hope for better than 5% and won't be surprised with less or a negative return. This was just a starting point)

I was hoping that someone could check my math to see if I'm doing the calculations correctly. Specifically regarding the taxes. (Or teach me a better way to do the comparison.)

I might need to look into comparing it to bond funds it might be a simpler comparison.
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Re: Use taxable account to pay off mortgage early?

Post by samsoes »

JoeRetire wrote: Fri Jan 21, 2022 12:12 pm
samsoes wrote: Fri Jan 21, 2022 6:27 am
JoeRetire wrote: Fri Jan 21, 2022 6:12 am
321jer wrote: Thu Jan 20, 2022 9:13 am Mortgage $220k
15 years @ 2.25%
Current Principle Payment - $1441

If instead, I invested it and it grew at 5% for 12.5 years, FV function says it'd be worth $51k ($37k principle, $14k growth)

(I'm also open to opinions about whether it is a good idea or not, but am primarily interested in checking the math).
So you want to pay off a 2.25% rate mortgage by selling investments that you assume will grow at 5%. And you still want to do it.

But you are asking for opinions about whether it is a good idea or not?
2.25% morrgage rate is guaranteed, 5% annual investment returns are not.

Furthermore, there is a huge peace of mind factor in paying off a mortgage, regardless of the potential forfeited returns. This is especially true if one's employment situation is precarious or one thinks another 2008-2009 market is forthcoming accompanied by a job loss.

I paid my mortgage off in 2014, and it was probably the best financial decision I ever made. I sleep much better at night.
The OP is assuming a 5% return over 12.5 years. The OP said nothing about needing a huge piece of mind factor and doesn't mention having problems sleeping at night.
Why else would someone want to pay off their mortgage early? Countless threads on this site indicate that's the reason.
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Admiral
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Re: Use taxable account to pay off mortgage early?

Post by Admiral »

321jer wrote: Fri Jan 21, 2022 1:30 pm Thanks all.

I do want to pay it off early(peace of mind, freedom etc)
But was hoping to avoid the downsides(loss of liquidity, paying with today's dollars vs 2030 dollars, not having a reduced payment until its paid off)

Investing in a taxable account (index funds) seems like a way to achieve the upside of paying off early and minimize the downsides.

I used 5% growth in the taxable account just to run some conservative numbers, and see if it would even be worth it after paying taxes. (I of course hope for better than 5% and won't be surprised with less or a negative return. This was just a starting point)

I was hoping that someone could check my math to see if I'm doing the calculations correctly. Specifically regarding the taxes. (Or teach me a better way to do the comparison.)

I might need to look into comparing it to bond funds it might be a simpler comparison.
You cannot properly estimate the taxes because the gain is uncertain. Keep in mind that any funds used to prepay (or invest in taxable) are after tax. So, for example, if you chose this route instead of completely maxing retirement accounts you’d be paying needless income tax (and losing tax free or tax deferred growth for decades) to save a small amount of mortgage interest.
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JoeRetire
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Re: Use taxable account to pay off mortgage early?

Post by JoeRetire »

samsoes wrote: Fri Jan 21, 2022 1:46 pm Why else would someone want to pay off their mortgage early? Countless threads on this site indicate that's the reason.
(shrug)
I would never presume to be able to guess what someone's thinking.

I've heard "I hate all debt", "there are no guarantees", "I can't sleep at night", "peace of mind", "I'll be able to invest the former mortgage payments", "something, something, reverse upside down bonds", yada, yada.

The OP did speak about expecting a 5% return on investments for 12.5 years. The OP did not speak about their motivation for paying off their mortgage early, other than "still want to".

If someone wants to say why, they can. If they don't, you can guess if you like, but I won't.
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ClassII
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Re: Use taxable account to pay off mortgage early?

Post by ClassII »

Another vote for not paying the mortgage early. At that interest rate it's essentially a free loan on the house. Not only would you be giving up gains on that money that could be put to work as an investment but you're locking that cash away for as long as you keep the house (or re-mortgage but then you're back to square one).

Yes if you put that money into equities the risk is higher, but we're talking about a huge investment time span (30 years for the mortgage). If you put $250 into VTI today and it goes down 30% because of today's market fluctuation, does it really matter in 30 years when the mortgage gets paid off? I'm guessing that $250 would balloon into a lot more by then. Plus, all along the way you'd have access to that money with a mere click of the mouse to sell VTI for whatever the market rate is that day. Much easier to do that than set up a second mortgage or sell the house.

Paying a mortgage that cheap early to me is the equivalent of the investor that only wants 100% safe investments. Would you be ok with that much money sitting in a CD or savings account? Yep it's 100% safe but in the end you're winning by losing as inflation eats your money a little every day.
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Re: Use taxable account to pay off mortgage early?

Post by Apathizer »

Anyone else feel good about paying down or off your mortgage recently? :D
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Re: Use taxable account to pay off mortgage early?

Post by KlangFool »

321jer wrote: Fri Jan 21, 2022 1:30 pm Thanks all.

I do want to pay it off early(peace of mind, freedom etc)
321jer,

How do you achieve that unless you are financially independence? If you are not Financially Independence, paying down your mortgage is not safe. In fact, it is a lot more risky due to the liquidity risk.

Even if you pay off the mortgage, you lose your house if you do not pay the property tax.

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Re: Use taxable account to pay off mortgage early?

Post by Apathizer »

KlangFool wrote: Mon Mar 07, 2022 7:16 pm
321jer wrote: Fri Jan 21, 2022 1:30 pm Thanks all.

I do want to pay it off early(peace of mind, freedom etc)
321jer,

How do you achieve that unless you are financially independence? If you are not Financially Independence, paying down your mortgage is not safe. In fact, it is a lot more risky due to the liquidity risk.

Even if you pay off the mortgage, you lose your house if you do not pay the property tax.

KlangFool
Keeping the mortgage is more risky due to the leverage. When you have a mortgage there's more risk since you're investing with leverage. Paying off the mortgage limits your potential losses.

Your investments can lose money and you're also paying mortgage interest. Historically paying down your mortgage and home appreciation is roughly equivalent to investing in bonds. So paying off the mortgage is sort of like investing in bonds with the additional benefits of eliminating debt.

When you sell your home you can invest the proceeds however you want. That's what you really need to think about. As long as you have debt, including mortgage debt, there's more risk.
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Re: Use taxable account to pay off mortgage early?

Post by Curiouslearner »

Like the OP, I have been paying extra principal each month (IR 2.850%) and am having second thoughts as it makes sense to invest the extra monthly amount and ear mark those funds to pay off the mortgage (in about 15 years for me). Klangfool made me see clearly in this post and some others I have read from him recently, that one is much more financially resilient investing the additional funds rather than paying down the mortgage early.
For someone who does not want to take too much risk with that ear marked money, what would be a reasonable asset allocation and investment vehicle examples? (I-bonds not an option for me here as I already purchase my maximum allocation each year for other goals). Thanks.
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Re: Use taxable account to pay off mortgage early?

Post by vp89 »

RE: liquidity risk.

What investment provides an equal or higher after-tax return to the current 30-year mortgage rate that has zero risk? If the investment can go down when I need the liquidity then wouldn't I have to pay however much it went down to benefit from that liquidity? If it has a zero or close enough risk but the return is lower than the mortgage rate, then wouldn't I be paying a spread to have that liquidity?

My original mortgage balance at 20% down was ~7x my current yearly expenses. How much liquidity does a typical salaried worker actually need?
Last edited by vp89 on Tue Jun 07, 2022 11:26 pm, edited 1 time in total.
strummer6969
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Re: Use taxable account to pay off mortgage early?

Post by strummer6969 »

Whatever helps you sleep at night is the correct answer. For some, that means investing rather than paying off the mortgage because they could never have peace of mind knowing they missed out on investment gains. For others, it means paying off the mortgage for the obvious psychological benefits of being debt free. It provides downside protection in the event of job loss and also gives you flexibility if you want to go part-time time, switch jobs, etc. Perhaps you could split between the two options. Use half of your extra cash paying down the mortgage and invest the other half.
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Re: Use taxable account to pay off mortgage early?

Post by grabiner »

Curiouslearner wrote: Tue Jun 07, 2022 10:34 pm Like the OP, I have been paying extra principal each month (IR 2.850%) and am having second thoughts as it makes sense to invest the extra monthly amount and ear mark those funds to pay off the mortgage (in about 15 years for me). Klangfool made me see clearly in this post and some others I have read from him recently, that one is much more financially resilient investing the additional funds rather than paying down the mortgage early.
For someone who does not want to take too much risk with that ear marked money, what would be a reasonable asset allocation and investment vehicle examples? (I-bonds not an option for me here as I already purchase my maximum allocation each year for other goals). Thanks.
If you aren't maxing out your 401(k), invest in a bond fund there. If you are maxing out, invest in a bond fund in your taxable account; I prefer munis if the tax rate on taxable bonds would exceed 25%. The most fair comparison is a fund which has similar duration to your mortgage, although munis have somewhat more interest-rate risk than is indicated by the duration.

With Admiral shares of Vanguard Long-Term Tax-Exempt yielding 3.29%, it doesn't make much sense to put extra money against a 2.85% mortgage. Even Intermediate-Term Tax-Exempt, with a 2.87% yield and a duration of 4.5 years, earns more than the mortgage rate; this would be the fair comparison to paying down a 5-year mortgage or paying off a 10-year mortgage,

In either case, if you have the muni fund and rates rise, you'll lose money on the munis but make it back in higher yields in the future, and the munis can still be used to make the mortgage payments. If rates fall, you can sell the muni fund for a capital gain and pay off the mortgage then.
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Wannaretireearly
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Re: Use taxable account to pay off mortgage early?

Post by Wannaretireearly »

Paid off roughly $50k mortgage last summer. Peace of mind for sure, no regrets.
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Re: Use taxable account to pay off mortgage early?

Post by placeholder »

I wouldn't pay it off regardless of source.
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Re: Use taxable account to pay off mortgage early?

Post by Tom_T »

The "peace of mind" angle has been endlessly discussed in the Forum. The conclusion from what I can see is that it is completely personal. Some people "sleep better at night" without the mortgage; others have no problem carrying the mortgage even when they have cash to pay it off, looking at it as strictly a mathematical exercise in maximizing the deployment of funds. There is no one answer.
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Re: Use taxable account to pay off mortgage early?

Post by KlangFool »

Tom_T wrote: Wed Jun 08, 2022 6:03 am The "peace of mind" angle has been endlessly discussed in the Forum. The conclusion from what I can see is that it is completely personal. Some people "sleep better at night" without the mortgage; others have no problem carrying the mortgage even when they have cash to pay it off, looking at it as strictly a mathematical exercise in maximizing the deployment of funds. There is no one answer.
Tom_T,

Except unless the person is financially independent, as soon as the person's employer start laying off people in the coming recession, the person would know that the "peace of mind" is not real.

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Re: Use taxable account to pay off mortgage early?

Post by Walobolo »

321jer wrote: Fri Jan 21, 2022 1:30 pm Thanks all.

I do want to pay it off early(peace of mind, freedom etc)
But was hoping to avoid the downsides(loss of liquidity, paying with today's dollars vs 2030 dollars, not having a reduced payment until its paid off)

Investing in a taxable account (index funds) seems like a way to achieve the upside of paying off early and minimize the downsides.

I used 5% growth in the taxable account just to run some conservative numbers, and see if it would even be worth it after paying taxes. (I of course hope for better than 5% and won't be surprised with less or a negative return. This was just a starting point)

I was hoping that someone could check my math to see if I'm doing the calculations correctly. Specifically regarding the taxes. (Or teach me a better way to do the comparison.)

I might need to look into comparing it to bond funds it might be a simpler comparison.
Just a word of warning on the peace of mind idea. Insurance and property tax do not go away after the payoff. Depending on what state you live in this could be a substantial amount of money that you will need to keep paying every year. Not saying there is no satisfaction in paying off the house but speaking from personal experience the peace of mind may be less than you think.

I don't think Klangfool said it yet but especially if you have kids don't pay off a 2.25% mortgage and then take out parent plus loans at 7% to pay for the kids college. A 15 year at only 2.25%...I would not pay that off early. Max 401k, Max HSA, do Roth IRA's, fund 429s. After all of that I would start a taxable account before ever thinking of paying an extra penny to the mortgage.
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Re: Use taxable account to pay off mortgage early?

Post by Tom_T »

KlangFool wrote: Wed Jun 08, 2022 6:17 am
Tom_T wrote: Wed Jun 08, 2022 6:03 am The "peace of mind" angle has been endlessly discussed in the Forum. The conclusion from what I can see is that it is completely personal. Some people "sleep better at night" without the mortgage; others have no problem carrying the mortgage even when they have cash to pay it off, looking at it as strictly a mathematical exercise in maximizing the deployment of funds. There is no one answer.
Tom_T,

Except unless the person is financially independent, as soon as the person's employer start laying off people in the coming recession, the person would know that the "peace of mind" is not real.

KlangFool
Agreed! I'm nearing retirement, so I'm not worried about my job, and I have money to pay off the loan if I wanted to; if I were younger, a paid-off mortgage isn't going to help me if I'm cash-poor and unemployed.
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Re: Use taxable account to pay off mortgage early?

Post by exodusNH »

Walobolo wrote: Wed Jun 08, 2022 6:30 am Just a word of warning on the peace of mind idea. Insurance and property tax do not go away after the payoff. Depending on what state you live in this could be a substantial amount of money that you will need to keep paying every year. Not saying there is no satisfaction in paying off the house but speaking from personal experience the peace of mind may be less than you think.

I don't think Klangfool said it yet but especially if you have kids don't pay off a 2.25% mortgage and then take out parent plus loans at 7% to pay for the kids college. A 15 year at only 2.25%...I would not pay that off early. Max 401k, Max HSA, do Roth IRA's, fund 429s. After all of that I would start a taxable account before ever thinking of paying an extra penny to the mortgage.
This is an important point. Unlike a fixed-rate mortgage, property taxes inexorably increase, barring something like a major business coming into town and reducing the home owner burden.

After 17 years, my taxes have gone from about $250/mo to about $450/mo. (Insurance has been about a constant $80/mo.) My mortgage (P+I) is $850.

In another 15 years, my taxes are likely going to be close to my mortgage payment. Being "mortgage free" in retirement doesn't mean all that much when you have equivalent -- and ultimately increasing -- monthly payments due in perpetuity.
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Re: Use taxable account to pay off mortgage early?

Post by strummer6969 »

Walobolo wrote: Wed Jun 08, 2022 6:30 am
321jer wrote: Fri Jan 21, 2022 1:30 pm Thanks all.

I do want to pay it off early(peace of mind, freedom etc)
But was hoping to avoid the downsides(loss of liquidity, paying with today's dollars vs 2030 dollars, not having a reduced payment until its paid off)

Investing in a taxable account (index funds) seems like a way to achieve the upside of paying off early and minimize the downsides.

I used 5% growth in the taxable account just to run some conservative numbers, and see if it would even be worth it after paying taxes. (I of course hope for better than 5% and won't be surprised with less or a negative return. This was just a starting point)

I was hoping that someone could check my math to see if I'm doing the calculations correctly. Specifically regarding the taxes. (Or teach me a better way to do the comparison.)

I might need to look into comparing it to bond funds it might be a simpler comparison.
Just a word of warning on the peace of mind idea. Insurance and property tax do not go away after the payoff. Depending on what state you live in this could be a substantial amount of money that you will need to keep paying every year. Not saying there is no satisfaction in paying off the house but speaking from personal experience the peace of mind may be less than you think.
So just keep some cash aside for property taxes and monthly expenses. Once the mortgage has been paid off, you'll need less for your emergency stach. If things really hit the fan, you can dip into your home equity which is preferable to selling stocks at a loss.

No one has any idea whether financially paying off early makes more sense. Statistically probably not but there are other benefits.
Last edited by strummer6969 on Wed Jun 08, 2022 8:39 am, edited 1 time in total.
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Re: Use taxable account to pay off mortgage early?

Post by HMSVictory »

When I realized my mortgage was a big negative bond I changed my AA from 70/30 to 90/10 and paid the mortgage off.

I did this in 2018 and haven't missed a penny of upside stock returns. I DCA my old mortgage payment into my taxable account.

Beyond the math and rationalization there is something that snaps inside of you when you don't owe anyone, anything. Its hard to describe and the best way I can explain it is it feels like you aren't carrying a weight around anymore. You also eliminate your largest monthly expense. I highly recommend it.
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Re: Use taxable account to pay off mortgage early?

Post by Church Lady »

2.25% mortgage rate is guaranteed, 5% annual investment returns are not.
Speaking of guarantees:
2 year CDs are paying 2.85%, (3 yr,3.15%),(5 yr,3.3%),(10 yr,3.7%)
Treasury zero coupon bonds: (2 yr, 2.6%),(3 yr,2.85%), (5 yr, 3.05%),(10 yr, 3.13%) <== maybe not in taxable

Only a bit higher on the risk spectrum:

Agency bonds: (1 yr, 2.38%),(2 yr, 2.86%),(3 yr, 3.25%),(5 yr,3.54%),(10 yr,4.51%)

For tax advantages that don't require you to itemize:
AAA municipal bonds (3 yr, 2.31%),(5 yr,2.45%),(10 yr, 3.63%)

Or how about Home Depot (tied to housing)? The dividend alone is 2.54%!

Even VTIP yields more but that's better in a tax deferred account, and will fluctuate.

Finding "guaranteed" returns above 2.25% these days is like shooting fish in a barrel!
Last edited by Church Lady on Wed Jun 08, 2022 9:13 am, edited 1 time in total.
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Re: Use taxable account to pay off mortgage early?

Post by exodusNH »

Church Lady wrote: Wed Jun 08, 2022 9:01 am
2.25% mortgage rate is guaranteed, 5% annual investment returns are not.
Speaking of guarantees:
2 year CDs are paying 2.85%, (3 yr,3.15%),(5 yr,3.3%),(10 yr,3.7%)
Treasury zero coupon bonds: (2 yr, 2.6%),(3 yr,2.85%), (5 yr, 3.05%),(10 yr, 3.13%)

Only a bit higher on the risk spectrum:

Agency bonds: (1 yr, 2.38%),(2 yr, 2.86%),(3 yr, 3.25%),(5 yr,3.54%),(10 yr,4.51%)

For tax advantages that don't require you to itemize:
AAA municipal bonds (3 yr, 2.31%),(5 yr,2.45%),(10 yr, 3.63%)

Or how about Home Depot (tied to housing)? The dividend alone is 2.54%!

Even VTIP yields more but that's better in a tax deferred account.

Finding "guaranteed" returns above 2.25% these days is like shooting fish in a barrel!
Remember, stock dividends are nothing like bond coupons. When Home Depot pays out a dividend, the share price drops by that amount. (I don't want to start a stock dividends war, but it's true -- there's even a FINRA rule that spells out that open orders are adjusted by the amount of the dividend.) It's essentially just moving money from your left pocket to right pocket.
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Re: Use taxable account to pay off mortgage early?

Post by Church Lady »

Remember, stock dividends are nothing like bond coupons. When Home Depot pays out a dividend, the share price drops by that amount. (I don't want to start a stock dividends war, but it's true -- there's even a FINRA rule that spells out that open orders are adjusted by the amount of the dividend.) It's essentially just moving money from your left pocket to right pocket.
It is quite true a stock dividend is not a bond coupon. I was just pointing out how easy it is to beat 2.25% these days. Dividend wars have been waged ad nauseam on Bogleheads and we don't need to do it again :) . OP can look it up if he is interested.

And any bond or CD is subject to inflation risk. If you believe in inflation, though, not only would you favor stocks above bonds, you would certainly not pay off a mortgage!

OP must not believe in inflation because he wants to pay off a 2.25% mortgage. He should be aware of how easy it is to beat 2.25% if inflation is not a concern for him.
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Re: Use taxable account to pay off mortgage early?

Post by Hyperchicken »

Church Lady wrote: Wed Jun 08, 2022 9:30 am It is quite true a stock dividend is not a bond coupon. I was just pointing out how easy it is to beat 2.25% these days. [...]
But you are not beating 2.25% mortgage by holding stocks yielding 2.5%+ in dividends (nor would a stock yielding 10% in dividends do that).

Let's just make sure we are not using flawed arguments to explain the right idea.
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Re: Use taxable account to pay off mortgage early?

Post by Church Lady »

But you are not beating 2.25% mortgage by holding stocks yielding 2.5%+ in dividends (nor would a stock yielding 10% in dividends do that).
Because?
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Re: Use taxable account to pay off mortgage early?

Post by Mr. Buzzkill »

HMSVictory wrote: Wed Jun 08, 2022 8:34 am When I realized my mortgage was a big negative bond I changed my AA from 70/30 to 90/10 and paid the mortgage off.

I did this in 2018 and haven't missed a penny of upside stock returns. I DCA my old mortgage payment into my taxable account.

Beyond the math and rationalization there is something that snaps inside of you when you don't owe anyone, anything. Its hard to describe and the best way I can explain it is it feels like you aren't carrying a weight around anymore. You also eliminate your largest monthly expense. I highly recommend it.
Yep. Having my mortgage paid off saved my bacon when I got laid off from my job and went over a year before finding a new comparable position.
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Re: Use taxable account to pay off mortgage early?

Post by exodusNH »

Church Lady wrote: Wed Jun 08, 2022 9:49 am
But you are not beating 2.25% mortgage by holding stocks yielding 2.5%+ in dividends (nor would a stock yielding 10% in dividends do that).
Because?
Because the dividend from a stock decreases the value of the stock by that amount. It is not interest. A company's cash is part of its assets and reflected in the stock price. When they pay a dividend, the cash is reduced, lowering the stock price, but you have the cash, leaving you whole, except that you now owe income tax. The dividend has reduced the value of your investment by that income tax.

If the company borrowed money to pay a dividend, then that loan is a liability, reducing the company's value by that amount.

In either case, the company is objectively worth less than before the dividend.

A bond's dividend is an interest payment. The face value of the bond does not decline by the amount paid.

People assign additional value to dividends. Some feel they're "not spending the principal." Others need to sell their stocks anyway in order to generate income. If they're getting a 2% dividend, that reduces what they need to sell. Maybe the dividends are enough by themselves. In any event, the dividend is really a forced microsale of a stock.

If this were not true, you could buy the stock before the ex-dividend date and sell it immediately after, pocketing the dividend and laughing all the way to the bank.
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Re: Use taxable account to pay off mortgage early?

Post by Hyperchicken »

Church Lady wrote: Wed Jun 08, 2022 9:49 am
But you are not beating 2.25% mortgage by holding stocks yielding 2.5%+ in dividends (nor would a stock yielding 10% in dividends do that).
Because?
You said it yourself -
Dividend wars have been waged ad nauseam on Bogleheads and we don't need to do it again
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