Paying off ARM (4.5%) or not?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
LeslieSmiley
Posts: 828
Joined: Fri May 08, 2015 7:43 pm

Paying off ARM (4.5%) or not?

Post by LeslieSmiley »

Hi all,

I took out a 7/1 ARM back in 2005 and when it matured in 2012, the rate dropped to 2.25% and i never refinanced and kept the mortgage. The rate had remained pretty much below 3% ever since then until now. The rate will rise to 4.5% as of July 1.

I am thinking of paying it off and would like to hear your thoughts and see if that’s a sound move.

Mortgage balance: $88k

Number of years remaining: 13 years

Interest rate: tracks 1-year treasury + 2.25% margin

Trying out early retirement now with modest annual expenses and no other debt
- lower 7-figure portfolio
- 70/30 AA which is probably 65/35 now with the current market downturn
- cash reserve (more than 10 years expenses in CDs and high yield savings)

I like liquidity but it seems to make sense to pay it off at 4.5% especially the balance is not that big.

After paying it off, i would still have enough cash flow to cover at least 10 years of expenses.

What are your thoughts?

Thanks
Leslie
drk
Posts: 3943
Joined: Mon Jul 24, 2017 10:33 pm

Re: Paying off ARM (4.5%) or not?

Post by drk »

I think 4.5% is a pretty solid guaranteed return, especially with all that cash sitting around. Off with its head arm.
A useful razor: anyone asking about speculative strategies on Bogleheads.org has no business using them.
exodusNH
Posts: 10347
Joined: Wed Jan 06, 2021 7:21 pm

Re: Paying off ARM (4.5%) or not?

Post by exodusNH »

LeslieSmiley wrote: Thu May 19, 2022 6:07 pm Hi all,

I took out a 7/1 ARM back in 2005 and when it matured in 2012, the rate dropped to 2.25% and i never refinanced and kept the mortgage. The rate had remained pretty much below 3% ever since then until now. The rate will rise to 4.5% as of July 1.

I am thinking of paying it off and would like to hear your thoughts and see if that’s a sound move.

Mortgage balance: $88k

Number of years remaining: 13 years

Interest rate: tracks 1-year treasury + 2.25% margin

Trying out early retirement now with modest annual expenses and no other debt
- lower 7-figure portfolio
- 70/30 AA which is probably 65/35 now with the current market downturn
- cash reserve (more than 10 years expenses in CDs and high yield savings)

I like liquidity but it seems to make sense to pay it off at 4.5% especially the balance is not that big.

After paying it off, i would still have enough cash flow to cover at least 10 years of expenses.

What are your thoughts?

Thanks
Leslie
Since it will have no material impact on your finances, I'd pay it off. No point in holding bonds returning 3% and a mortgage you're paying 4.5% on, especially if you use the standard deduction.
DVMResident
Posts: 1814
Joined: Mon Aug 01, 2011 8:15 pm

Re: Paying off ARM (4.5%) or not?

Post by DVMResident »

4.5%/13 post-tax, guaranteed is a "good" deal now and rates are expected to increase at the June meeting.

However, your balance is so small that it only save ~$3700/yr of interest to start and down from there as the principle decreases; and that doesn't include opportunity cost on the cash (although it's just in a savings account). IMO this does not move the needle much vs a seven-figure portfolio, but, yeah, paying it off makes sense. Shrug.
dred pirate
Posts: 667
Joined: Tue Nov 27, 2018 10:46 am

Re: Paying off ARM (4.5%) or not?

Post by dred pirate »

Sounds like you have plenty of liquidity / cash equivalents. Pay it off seems like a no-brainer. Ask yourself this. Would you borrow $88k at 4.5% in order to invest it today? Add to that that the rate is likely to only go up.
Harmanic
Posts: 935
Joined: Mon Apr 04, 2022 10:19 am

Re: Paying off ARM (4.5%) or not?

Post by Harmanic »

drk wrote: Thu May 19, 2022 6:15 pm I think 4.5% is a pretty solid guaranteed return, especially with all that cash sitting around. Off with its head arm.
Not to mention taxes. Paying off a 4.5% loan is like getting a 6% to 7% pretax return.
The question isn't at what age I want to retire, it's at what income. | - George Foreman
Bud
Posts: 366
Joined: Sun Jul 22, 2007 6:59 am

Re: Paying off ARM (4.5%) or not?

Post by Bud »

Yes - if you have doubts, pay off 50% ($44k), see how you feel. If it feels 'right', pay off the rest. If you miss the liquidity, design your own accelerated payment plan to pay off the remainder in 3 or 5 years.

For my personal residence and rental properties, I usually have a loan and then design my own accelerated repayment plans. I enjoy liquidity and have regularly held cash but there is a beauty in being debt free.

All the best.
Topic Author
LeslieSmiley
Posts: 828
Joined: Fri May 08, 2015 7:43 pm

Re: Paying off ARM (4.5%) or not?

Post by LeslieSmiley »

Harmanic wrote: Thu May 19, 2022 9:04 pm
drk wrote: Thu May 19, 2022 6:15 pm I think 4.5% is a pretty solid guaranteed return, especially with all that cash sitting around. Off with its head arm.
Not to mention taxes. Paying off a 4.5% loan is like getting a 6% to 7% pretax return.

Thank you all for your inputs.

Can you please elaborate on the 6-7% pretax return part?
Harmanic
Posts: 935
Joined: Mon Apr 04, 2022 10:19 am

Re: Paying off ARM (4.5%) or not?

Post by Harmanic »

LeslieSmiley wrote: Fri May 20, 2022 11:24 am
Harmanic wrote: Thu May 19, 2022 9:04 pm
drk wrote: Thu May 19, 2022 6:15 pm I think 4.5% is a pretty solid guaranteed return, especially with all that cash sitting around. Off with its head arm.
Not to mention taxes. Paying off a 4.5% loan is like getting a 6% to 7% pretax return.

Thank you all for your inputs.

Can you please elaborate on the 6-7% pretax return part?
Assuming a 30% tax rate on your investments, you would need to earn 6.4% before tax to equal 4.5% after tax. If you use a standard deduction, you don't get any tax breaks on your mortgage interest, so paying it off would be like getting 6.4% on your pre-tax investment.
The question isn't at what age I want to retire, it's at what income. | - George Foreman
harikaried
Posts: 2613
Joined: Fri Mar 09, 2012 2:47 pm

Re: Paying off ARM (4.5%) or not?

Post by harikaried »

Harmanic wrote: Fri May 20, 2022 3:20 pmAssuming a 30% tax rate on your investments, you would need to earn 6.4% before tax to equal 4.5% after tax
So even with I Bonds at current annualized rates, it might still be worthwhile to pay down this mortgage as future I Bonds rates might drop averaging less than 6%?

Bond funds currently have SEC yield around 3%, so it looks like it's probably worthwhile to even sell bonds to pay down the mortgage.
Topic Author
LeslieSmiley
Posts: 828
Joined: Fri May 08, 2015 7:43 pm

Re: Paying off ARM (4.5%) or not?

Post by LeslieSmiley »

Harmanic wrote: Fri May 20, 2022 3:20 pm
LeslieSmiley wrote: Fri May 20, 2022 11:24 am
Harmanic wrote: Thu May 19, 2022 9:04 pm
drk wrote: Thu May 19, 2022 6:15 pm I think 4.5% is a pretty solid guaranteed return, especially with all that cash sitting around. Off with its head arm.
Not to mention taxes. Paying off a 4.5% loan is like getting a 6% to 7% pretax return.

Thank you all for your inputs.

Can you please elaborate on the 6-7% pretax return part?
Assuming a 30% tax rate on your investments, you would need to earn 6.4% before tax to equal 4.5% after tax. If you use a standard deduction, you don't get any tax breaks on your mortgage interest, so paying it off would be like getting 6.4% on your pre-tax investment.
Thanks for the explanation. It seems that it’s a no brainer to pay it off.
User avatar
Watty
Posts: 28860
Joined: Wed Oct 10, 2007 3:55 pm

Re: Paying off ARM (4.5%) or not?

Post by Watty »

LeslieSmiley wrote: Mon May 23, 2022 1:18 pm It seems that it’s a no brainer to pay it off.
I agree.

With a seven figure portfolio you likely have something like half a million(or more) in bonds that are paying around 2%. That makes it real hard to come out ahead when you have a mortgage at a higher interest rate.

If it was a large mortgage your decision might be more complex.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Paying off ARM (4.5%) or not?

Post by grabiner »

Since you have an ARM, the fair bond rate to use for comparison is the one-year rate, not the rate for the remaining term. The reason is that the ARM refinances every year. If you buy a one-year bond with a yield equal to your ARM rate, and use that bond to pay down the ARM next year, your balance and payments will be the same as if you paid down the ARM now. (In contrast, if you have 15 years left on a mortgage, buying a 15-year bond with a yield equal to the mortgage rate and using it to make the final payment is equivalent to paying it down.)

Given that, paying down or off the ARM is a good idea, as 4.5% is a great return on a short-term investment.

Another benefit of paying it off is that you will need a smaller cash reserve, since you will have eliminated a fixed expense. If you are keeping 10 years of expenses in CDs and savings, you can sell enough CDs and cash in enough savings to pay off a 10-year mortgage and still have 10 years of expenses covered.
Wiki David Grabiner
User avatar
Metsfan91
Posts: 1019
Joined: Sat Jan 11, 2020 11:33 am
Location: Rust Belt

Re: Paying off ARM (4.5%) or not?

Post by Metsfan91 »

Yes, pay it off!
"Know what you own, and know why you own it." — Peter Lynch
User avatar
fishandgolf
Posts: 794
Joined: Fri Nov 25, 2016 1:50 pm

Re: Paying off ARM (4.5%) or not?

Post by fishandgolf »

Metsfan91 wrote: Tue May 24, 2022 11:04 pm Yes, pay it off!
+100%

Pay it off......do not hesitate. We paid ours off in 2010 and that feeling of 'NO MORE DEBT" feels fabulous!!!! :sharebeer
manuvns
Posts: 1465
Joined: Wed Jan 02, 2008 1:30 pm

Re: Paying off ARM (4.5%) or not?

Post by manuvns »

I have not paid off any debt 4.5% or below early , i would rather invest in my retirement account .
Thanks!
invest4
Posts: 1905
Joined: Wed Apr 24, 2019 2:19 am

Re: Paying off ARM (4.5%) or not?

Post by invest4 »

In your particular case, I would also support paying it off. A reasonable return and one less thing to be bothered about.
Tamalak
Posts: 1989
Joined: Fri May 06, 2016 2:29 pm

Re: Paying off ARM (4.5%) or not?

Post by Tamalak »

If it were a much higher balance I'd say keep it - even conservative expected future returns in stocks are higher than 4.5% nominal - but I'd say pay it off just because the balance is so low compared to your net worth to bother with the paperwork. There's a spiritual value in being debt free that's hard to put a number to.
Topic Author
LeslieSmiley
Posts: 828
Joined: Fri May 08, 2015 7:43 pm

Re: Paying off ARM (4.5%) or not?

Post by LeslieSmiley »

manuvns wrote: Wed May 25, 2022 9:42 am I have not paid off any debt 4.5% or below early , i would rather invest in my retirement account .
The opportunity cost factor does not quite apply in my case as illustrated in my original post as i plan to use my cash reserve to pay it off. In other words, the fund that i use to pay it off would not be invested in the market if i don’t pay it off.
Topic Author
LeslieSmiley
Posts: 828
Joined: Fri May 08, 2015 7:43 pm

Re: Paying off ARM (4.5%) or not?

Post by LeslieSmiley »

grabiner wrote: Tue May 24, 2022 9:53 pm Since you have an ARM, the fair bond rate to use for comparison is the one-year rate, not the rate for the remaining term. The reason is that the ARM refinances every year. If you buy a one-year bond with a yield equal to your ARM rate, and use that bond to pay down the ARM next year, your balance and payments will be the same as if you paid down the ARM now. (In contrast, if you have 15 years left on a mortgage, buying a 15-year bond with a yield equal to the mortgage rate and using it to make the final payment is equivalent to paying it down.)

Given that, paying down or off the ARM is a good idea, as 4.5% is a great return on a short-term investment.

Another benefit of paying it off is that you will need a smaller cash reserve, since you will have eliminated a fixed expense. If you are keeping 10 years of expenses in CDs and savings, you can sell enough CDs and cash in enough savings to pay off a 10-year mortgage and still have 10 years of expenses covered.
Good point. My annual expense will decrease as a result of the absence of monthly mortgage payment, hence, my fixed income pot will last me probably a same period of time.
Post Reply