Paying Off Mortgage vs Investing Extra Money

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Colorado21a
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Paying Off Mortgage vs Investing Extra Money

Post by Colorado21a »

Hello all, first post on this site after reading The Bogleheads Guide to Investing, many decades too late but better late than never. Really looking forward to interacting with everyone on here going forward.

I have a quick question. My wife and I bought a home 2 years ago on a 30 year fixed mortgage at a great rate of 2.75%. We will be paying off that mortgage well into retirement if we just keep making monthly payments only. We earn enough income that we could easily pay off significantly more each month/year and burn the mortgage down to probably 15-20 years.

My question is that at the above rate vs what can be made through investing it makes sense to smartly invest the money and pay off the mortgage at a later time. Is it pretty much that simple or are there more complexities that I'm missing? We have many different investments and I'm in the process of following the blueprint in the book of evaluating fees, rebalancing to my desired mix, etc. As an example, we are earning today about 5% in our checking/savings account on our slight surplus money each month after maxing out our 401k's, etc.

Thanks everyone!!!
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oldcomputerguy
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Re: Paying Off Mortgage vs Investing Extra Money

Post by oldcomputerguy »

This topic is now in the Personal Finance forum.
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6bquick
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Re: Paying Off Mortgage vs Investing Extra Money

Post by 6bquick »

The only confounding factor usually mentioned on here is taxes.

your 2.75% is likely lower after interest is deducted on schedule A. also the 5% you're earning in savings is lower too because it's taxed as income.

that's pretty much it for the arithmetic. all else is intangible.

at 2.75%, with an even lower effective rate, I'd sleep just fine not paying an extra nickel on that loan and saving/investing any extra. there are myriad fdic insured accounts paying 1%+ greater than that. and an even bigger delta in MMF. In fact, that's exactly what we do. we have 28.5yrs left on our 2.69% mortgage, which I plan on paying off in 28.5yrs.
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Jimbo Moneybags
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Jimbo Moneybags »

Just keep putting the extra money in a brokered CD or treasury earning 5%+ until the balance of those saved funds = your loan balance. Then decide whether to payoff your loan in full or not. That's what I'd do. :happy
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Colorado21a
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Colorado21a »

We currently have a combo checking/savings where the extra money we keep in savings is earning 5% today so we've started doing that vs paying off extra each month. I will go look into your suggestions about a brokered CD or treasury as I'm sure there are signficant tax savings possible doing it that way vs paying taxes on the 5% I'm currently earning.

Thanks.
exodusNH
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Re: Paying Off Mortgage vs Investing Extra Money

Post by exodusNH »

gardn202926 wrote: Thu Jun 08, 2023 7:59 am We currently have a combo checking/savings where the extra money we keep in savings is earning 5% today so we've started doing that vs paying off extra each month. I will go look into your suggestions about a brokered CD or treasury as I'm sure there are signficant tax savings possible doing it that way vs paying taxes on the 5% I'm currently earning.

Thanks.
Unless you hold these in an IRA, there are no tax savings, with the exception that Treasury interest is not taxable at the state level.

At 2.75%, I would not pay a $1 more than necessary on the mortgage. You can either follow your asset allocation with the extra funds, or save the extra into a savings account / bond fund / Treasury. If interest rates ever go below your mortgage rate, you can pay it down then and perhaps even do a recast to lower your required payment.

Assuming the Fed manages to get inflation to it's target, it's unlikely that interest rates will ever go that low again. There are some good arguments that inflation will remain above the target due to demographic and supply chain reorganization pressures.
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Watty
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Watty »

gardn202926 wrote: Thu Jun 08, 2023 7:19 am Is it pretty much that simple or are there more complexities that I'm missing?
A couple of things that you may be missing.

1) It is not exact but in many ways having a mortgage is sort of like having a negative bond in your asset allocation. There are lots of old threads like that. For example in very rough numbers if you have a million dollar portfolio and you want a 70% stock and 30% bond asset allocation then you would have $700K in stocks and $300K in bonds. If you also had a $100K mortgage and an additional $100K in stocks that you bought with your mortgage money then if you count your mortgage as a negative bond you would have $800K in stocks and $200K in bonds which may be a more agressive asset allocation than you were planning on. Again the "mortgage as a negative bond" analogy is not exact but there is a lot of truth in that.

2) Aggressively paying down your mortgage may mean that you are not able to max out all your tax advantaged accounts like 401k accounts. I am usually in the "pay it off" cheerleading camp but I would have a hard time justifying paying off a low interest rate mortgage if you were not also maxing out all your retirement accounts.

3) If you just send in extra each month that just shortens the length of your mortgage. An alternative is to save up maybe 20% of your mortgage or whatever makes sense then contacting 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 if you send in something like 20% of your loan amount in a recase then your required monthly payment will be reduced by the same percentage but the interest rate and length of the mortgage will stay the same. This can be important if something happens like you are laid off or disabled or interest rates get even higher.

4) If you keep a mortgage you could pay down so you can invest the money then you will have more sequence of returns risk. Here is a very simplistic example of that which I wrote up when interest rates were lower. You may want to play with your number looking at it this way.
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://investor.vanguard.com/investing ... allocation

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.
I really like the idea of having a paid off mortgage especially in retirement but if I was in your situation I would keep putting the money into something like 5% CD or money market funds which are separate from the rest of your portfolio asset allocation then you can decide what you want to do in a couple of years when the situation may be clearer.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by FrugalConservative »

This in someways is a very personnal decision. Invest or payoff that is. I have a 3.75 mortgage rate. I'm paying my mortgage off next month. Granted I am in the top tax bracket ( so I'll actually save a touch by paying off vs investing in a money market/cd) and I max out all my tax deferred space.

Yes , it may not be perfect in the eyes on many (better return in market, blah blah blah camp) but knowing I have no debt willl be freeing for me, especially since I have a high stress job.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Chadnudj »

The other aspect being missed here, somewhat, is inflation. A 2.75% fixed rate mortgage is insanely low, and (at least at present) lower than the rate of inflation. Inflation being higher means you're paying this fixed rate loan back with cheaper and cheaper dollars -- indeed, the inflation is wiping out the interest right now.
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bligh
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Re: Paying Off Mortgage vs Investing Extra Money

Post by bligh »

I wouldn’t pay a loan that low back early. I would hold it for as long as possible.

If I wanted to becomr mortgage free, I would setup a separate brokerage account and invest money in there until it matched the remaining balance on my mortgage and then pay it off all at once.

Paying it off a small chunk at a time is not only not getting you a very good return, but it is also reducing your liquidity while having no effect on your monthly payment. (Though recasts are often available for significant changes in loan balance)
twh
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Re: Paying Off Mortgage vs Investing Extra Money

Post by twh »

As many have said, you can make more in a T-bill fund right now than you can save by paying off your mortgage early.
That has not been the case for a decade or more until very recently.
I've had a fully paid off mortgage and it is a nice feeling.
My current mortgage rate is about the same as the current best T-bill fund rate I could get, so I'm just putting extra in to pay the mortgage off in 10 years rather than 30.
NashTransplant
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Re: Paying Off Mortgage vs Investing Extra Money

Post by NashTransplant »

Recently made this calculus myself. Have 8 years left on a 10 year refi mortgage at 2.5%.

I put the $$ into a CD @ 5% to kick the can down the road, and I will keep kicking the can down the road as long as I can. My preference is to just pay the mortgage over 8 years. For peace of mind, I like knowing I could pay it off via the CD at any point. The things that might lead to my doing it - 1) getting laid off. 2) Taking a lower paying job to work on something I believe in more.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by jsapiandante »

What's more important to you? Being debt free or having as much money as possible? Before you even consider paying down your mortgage, at least max all your retirement vehicles (401k, IRA, etc) and pay down any consumer debt you may have as well as having 6-12 months emergency fund. The mortgage would be at the very bottom of things I want to pay off. If you aren't maxing out your retirement, why pay your income tax rate to save a measly 2.75% mortgage rate that's deductible? It doesn't make sense. Especially in this high inflationary environment and the economy in turmoil.

The risk of paying down the mortgage is liquidity risk. If you're plowing all your extra cash into the mortgage and an emergency happens like a job loss, the same monthly mortgage payment still needs to be paid (plus property tax and insurance). If you end up not finding a job within what your emergency fund can cover, you have the risk of losing your home.

At that mortgage rate, I wouldn't pay a penny over what I'm suppose to pay. I'd start a sinking fund and plow all extra cash into that and when it's big enough to pay the mortgage in full, I would just go ahead and do it then. This is what I did. I now have more than enough to pay my mortgage off in full if I wanted to but I still value liquidity more as it gives me a lot of options should an emergency arise.
mikejuss
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Re: Paying Off Mortgage vs Investing Extra Money

Post by mikejuss »

What is your mortgage amount, OP?
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Colorado21a
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Colorado21a »

Mortgage amount is $1M remaining over 28 more years so don't get the full credit of the interest for tax purposes. My wife and I both max out our 401K contribution limits each year, but am also looking at investing the overage into a backdoor Roth IRA which I'm in the process of learning more about.
solarcub
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Re: Paying Off Mortgage vs Investing Extra Money

Post by solarcub »

Chadnudj wrote: Thu Jun 08, 2023 10:38 am The other aspect being missed here, somewhat, is inflation. A 2.75% fixed rate mortgage is insanely low, and (at least at present) lower than the rate of inflation. Inflation being higher means you're paying this fixed rate loan back with cheaper and cheaper dollars -- indeed, the inflation is wiping out the interest right now.
I feel like inflation is actually an argument for paying it off now. I am late-career, my company gives lousy raises these days, and my salary isn't close to keeping up with inflation. So my mortgage is getting harder to pay every year. Dollars are only cheaper if you can get more and more of them.
exodusNH
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Re: Paying Off Mortgage vs Investing Extra Money

Post by exodusNH »

solarcub wrote: Thu Jun 08, 2023 4:10 pm
Chadnudj wrote: Thu Jun 08, 2023 10:38 am The other aspect being missed here, somewhat, is inflation. A 2.75% fixed rate mortgage is insanely low, and (at least at present) lower than the rate of inflation. Inflation being higher means you're paying this fixed rate loan back with cheaper and cheaper dollars -- indeed, the inflation is wiping out the interest right now.
I feel like inflation is actually an argument for paying it off now. I am late-career, my company gives lousy raises these days, and my salary isn't close to keeping up with inflation. So my mortgage is getting harder to pay every year. Dollars are only cheaper if you can get more and more of them.
"Inflation" isn't a single number. A big component of it is housing costs. Since you already own your home, that doesn't directly apply to you and so lowers your personal inflation number.

Automobiles are another big component. If you haven't bought a car in the last three years, then it also doesn't apply to you.

But since you can easily and safely earn an interest rate higher than 2.75%, you come about ahead saving money now and then making a lump payment when interest rates drop.
invest4
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Re: Paying Off Mortgage vs Investing Extra Money

Post by invest4 »

My current mortgage is similar to yours @ 2.625%.

I am still in the accumulation phase and very much value my historically low mortgage which provides me with:

* Protection against inflation

* Liquidity

* Leverage for further investment


Unless conditions change, I will continue to pay back this low cost loan with inflated dollars per schedule.

Best wishes.
Pdxnative
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Pdxnative »

I wouldn’t pay an extra cent at that rate. You can make a better return and preserve liquidity by paying the minimum. Why would you give up those advantages? The sequence of returns risk is real but not something you need to worry about until nearing retirement, and even then only if you’re investing in riskier assets. When you can beat the mortgage cost with money market and CD returns it makes no sense to pay down the mortgage.

I would save the extra until mortgage cost exceeds low risk return after taxes. At that point you can consider how much you value liquidity and pay down or not as appropriate. (I knew plenty of people who minimized the value of liquidity until the financial crisis when they realized equity in the house was not the same as money in the bank, especially if they lost their job).
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Re: Paying Off Mortgage vs Investing Extra Money

Post by grabiner »

Chadnudj wrote: Thu Jun 08, 2023 10:38 am The other aspect being missed here, somewhat, is inflation. A 2.75% fixed rate mortgage is insanely low, and (at least at present) lower than the rate of inflation. Inflation being higher means you're paying this fixed rate loan back with cheaper and cheaper dollars -- indeed, the inflation is wiping out the interest right now.
Inflation isn't directly relevant. If you keep the mortgage and invest the money, inflation reduces the value of your investments by the same amount it reduces the value of the mortgage payments.

The easiest way to see this is by comparing a bond to a mortgage prepayment. If you hold a bond which will be worth $10K in the last year of your mortgage, and you pay $10K in mortgage payments that year, you break even regardless of what happens to inflation. And since long-term municipal bonds are yielding more than 2.75%, you can buy low-risk bonds which will cover more in mortgage payments than prepaying the mortgage would give you, so there is no reason to pay it down.

Inflation is indirectly relevant because inflation expectations affect bond yields. If long-term inflation expectations are high, long-term bond yields will also need to be high,
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Re: Paying Off Mortgage vs Investing Extra Money

Post by slalom »

One thing to consider that Is very practically relevant - a lot of people ask the question 'should I put extra to my mortgage principal or invest?' but unless you are literally doing one or the other (extra mortgage vs auto-investment of x amount) it's not really apples to apples. I think most people that decide to pay extra mortgage or not just do that or not, rather than automatically setting an auto-investment of that amount. If you're not doing that, it's just added to the pot of money that could be spent any which way you feel like at the time.. maybe you'll invest it, maybe you won't.

Make sure to ACTUALLY do one or the other, every month automatically, without your needing to manually do anything.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by ClemsonBogle »

Gawd this topic....one i personally struggle with.
I live in a M/HCOLA but have no state income tax (FL). I caught a great time to refi and got a 15 year at 1.75% ~2 years ago with no points. At the time i was coming from a 3.375 30 year so the payment change was negligeable but i was able to cut the interest and term in half.

My financial hat says - I should have cashed out at the time and taken a larger mortgage at that rate. My total housing PITI comes in at around 15% of my Gross so all calculators (including my own gut feeling) means i could have taken out a bigger mortgage and had that cash available.
At the time - I wasnt sure if we were going to be staying in the area long term so i was somewhat conservative (also inflation had not kicked in on anything but cars AND i am pretty sure my money market etc were all paying ~1%).

Now (i'm 46) I have maxed my tax advantaged accounts, we have a large cash (dry powder stash) earning ~5%, i am investing in after tax automatically, and the thought of setting up ANOTHER account to accumulate the pay down and earn extra interest seems "shrugs" unnecessary to me. I could pay it off right now with the cash stash. I could put more in that account i guess treating it as an accumulation account, BUT my compromise was looking at a target age "55"...I dont want to have a mortgage anymore at that point, i have 9 years... so i am sending extra to the mortgage every month to hit that target.

Is it the most efficient No, i know it isnt, but there is something about getting this last liability off my balance sheet that is important to me. I am not going all in against it... but just a small acceleration to hit a date in life, scratches that itch for me (aka paying off in ~10 vs ~15).

All that said i am almost 100% sure that when the balance gets to sub 30K im just going to like write a check and not think twice about it...
afr
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Re: Paying Off Mortgage vs Investing Extra Money

Post by afr »

At what interest rate on a mortgage becomes the dividing line between paying it off or not?
A Random Fellow
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Re: Paying Off Mortgage vs Investing Extra Money

Post by A Random Fellow »

afr wrote: Sat Jun 10, 2023 6:57 am At what interest rate on a mortgage becomes the dividing line between paying it off or not?
Depends on asset allocation, marginal income tax rate and LTCG rates, assumed returns, percentage of dividends that are qualified or not, and where your invested funds would be placed (tax advantaged or not?).

This answer will vary widely.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

afr wrote: Sat Jun 10, 2023 6:57 am At what interest rate on a mortgage becomes the dividing line between paying it off or not?
I would use two criteria:
1) is taking standard deduction more beneficial on your tax return than keeping the mortgage?
2) is there any other guaranteed return instrument that can provide same after tax yield as the mortgage interest?

YES to the first question and NO to the second question = payoff or paydown.

For the first question, the rate is AN input but not the only input. Mortgage amount also comes into play.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by ler65 »

lakpr wrote: Sat Jun 10, 2023 12:40 pm
afr wrote: Sat Jun 10, 2023 6:57 am At what interest rate on a mortgage becomes the dividing line between paying it off or not?
I would use two criteria:
1) is taking standard deduction more beneficial on your tax return than keeping the mortgage?
2) is there any other guaranteed return instrument that can provide same after tax yield as the mortgage interest?

YES to the first question and NO to the second question = payoff or paydown.

For the first question, the rate is AN input but not the only input. Mortgage amount also comes into play.
Hi
In my particular situation, I take the standard deduction and have a mortgage balance of 43,700 with a 4% interest rate.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

ler65 wrote: Sat Jun 10, 2023 4:06 pm
lakpr wrote: Sat Jun 10, 2023 12:40 pm
afr wrote: Sat Jun 10, 2023 6:57 am At what interest rate on a mortgage becomes the dividing line between paying it off or not?
I would use two criteria:
1) is taking standard deduction more beneficial on your tax return than keeping the mortgage?
2) is there any other guaranteed return instrument that can provide same after tax yield as the mortgage interest?

YES to the first question and NO to the second question = payoff or paydown.

For the first question, the rate is AN input but not the only input. Mortgage amount also comes into play.
Hi
In my particular situation, I take the standard deduction and have a mortgage balance of 43,700 with a 4% interest rate.
Since you are taking the standard deduction, that 4% interest rate is completely after tax. If you are in the 22% Federal tax bracket and an assumed 5% state tax rate (your specific state tax rate may vary, I assumed a middle-of-the-road tax rate here), it's equivalent to earning 4% / (1 - 22% - 5%) = 5.5% guaranteed return.

Would you be tempted by a bank offering you 5.5% CD rate, except that it is capped at $40k maximum amount? If you are, pay off the mortgage; both are financially equivalent. [ Edit: to extend the analogy a bit further and make it more equivalent; if you were to break this hypothetical CD earlier than maturity, the bank would charge you $1,000 early withdrawal penalty, earned or unearned. That is 2.5% * $40k; the 2.5% being the difference in the mortgage rate you would get if you were to refinance, 6.5% assumed ]

If you are in any higher tax bracket than 27% (Fed + State combined), your implicit return is even higher. I am in NJ, my marginal tax bracket is 24% + 6.6% = 30.6%, so if I were carrying a 4% interest rate, it would be equivalent to earning 5.77% for me. Actually probably higher, probably 6.1%, since I am also subject to NIIT if I were to invest.

If I were you, given this small balance, I will pay it off tomorrow and not look back.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by tixoboy »

This is a complex topic that depends a lot on your individual circumstance and holistic financial plan. One thing I want to point out here is that the "5%" interest rate being quoted in many posts on this thread is a short-term interest rate that isn't guaranteed for any meaningful period of time compared to 28 years. To "lock in" the interest rate, you'd have to purchase a fixed-income investment like a CD or bond with a particular maturity and duration. If your cash is sitting in a checking/savings account and could otherwise be used to purchase a bond that matures in the future to make your mortgage payment in the future, you are technically exposing yourself to reinvestment risk on your cash today since the relatively high savings interest rate (compared to when you originated your mortgage) could come down at any time, leaving you with funds that can only be invested at a low interest rate.

The bond market actually expects interest rates to decline in the future, as long-duration bonds yield lower than short-term bonds:

US treasury yields at today's prices:
1M - 5.203%
3M - 5.32%
5Y - 3.95%
10Y - 3.87%
30Y - 3.78%

Depending on your specific tax situation and cash flows needs between now and into retirement, and a rate of 2.75%, it might make financial sense to not pay any extra money on your mortgage and invest the money into bonds with maturities between 1M and 28Y that you can use to pay off your mortgage.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by grabiner »

afr wrote: Sat Jun 10, 2023 6:57 am At what interest rate on a mortgage becomes the dividing line between paying it off or not?
The absolute minimum is the rate on low-risk bonds of the same duration. If you can buy a 10-year bond yielding 4%, or pay down your 10-year mortgage to 9 years, it costs nothing to hold the bond instead of paying down the mortgage at 4%. If you are considering paying off the mortgage, the right bond comparison is a bond of duration equal to the whole mortgage, which is a bit less than 5 years for a 10-year mortgage, and about 11 years for a 30-year mortgage. (The reason the duration of the mortgage is less half the term is that the payments in later years have lower present value.)

If your rate is above that level, the difference is the dollar cost, and you have to weigh that dollar cost against any other benefit. It's usually worthwhile to max out a 401(k)/IRA in preference to paying down a loan at a slightly lower rate, because you get the long-term benefit of tax-advantaged savings. If you are already maxing out your retirement accounts, you have to decide how much to value liquidity, and the option retained of paying off the mortgage for an even larger benefit if rates fall further.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by tixoboy »

FWIW, my spouse has a mortgage exactly at 2.75% as well which ends October 2050 with about a $390k balance. If we "paid it off" today by building a US treasuries ladder with monthly maturity between now and October 2050 and use those maturing bonds to pay off the mortgage, it would cost ~$340-$350k (this ignores having to pay tax on the gains, so that also has to be factored in).
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

tixoboy wrote: Sat Jun 10, 2023 8:37 pm FWIW, my spouse has a mortgage exactly at 2.75% as well which ends October 2050 with about a $390k balance. If we "paid it off" today by building a US treasuries ladder with monthly maturity between now and October 2050 and use those maturing bonds to pay off the mortgage, it would cost ~$340-$350k (this ignores having to pay tax on the gains, so that also has to be factored in).
In this particular case, annual mortgage interest is $10,750; plus SALT deduction of maximum $10k would put the total itemized deductions at $20,750. This is less than standard deduction of $27,700 so that 2.75% rate is after tax.

To earn a 2.75% after tax return you will need to earn 2.75% ÷ (1 - 22% - 5%) = 3.75% in a bond. 22% and 5% are assumed Federal and State tax brackets.

Given that short term treasuries are yielding 5%, the answer is to invest than pay extra on the mortgage.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by grabiner »

lakpr wrote: Sat Jun 10, 2023 9:00 pm
tixoboy wrote: Sat Jun 10, 2023 8:37 pm FWIW, my spouse has a mortgage exactly at 2.75% as well which ends October 2050 with about a $390k balance. If we "paid it off" today by building a US treasuries ladder with monthly maturity between now and October 2050 and use those maturing bonds to pay off the mortgage, it would cost ~$340-$350k (this ignores having to pay tax on the gains, so that also has to be factored in).
In this particular case, annual mortgage interest is $10,750; plus SALT deduction of maximum $10k would put the total itemized deductions at $20,750. This is less than standard deduction of $27,700 so that 2.75% rate is after tax.
Unless you donate a lot to charity, this is correct.
To earn a 2.75% after tax return you will need to earn 2.75% ÷ (1 - 22% - 5%) = 3.75% in a bond. 22% and 5% are assumed Federal and State tax brackets.

Given that short term treasuries are yielding 5%, the answer is to invest than pay extra on the mortgage.
The correct comparison is to a bond of the same duration. which would be a long-term bond, not a short-term bond. If you make an extra payment on the mortgage, you get a fixed amount of money in 27 years (or possibly earlier if you sell the house). If you buy a long-term bond, you also get a fixed amount of money when the bond matures.

But even that justifies investing in preference to paying off the mortgage early. Vanguard Extended-Duration Treasury ETF, which holds very-long-term zero-coupon Treasuries, currently yields 4.08%. A more likely comparison is Vanguard Long-Term Bond Index, with a 15-year duration and some corporate bonds; it yields 4.84%. I would prefer either of these funds to paying down a 2.75% mortgage in a 22% bracket. (And in a higher bracket, I would similarly prefer Vanguard Long-Term Tax-Exempt, or the long-term muni fund for your state if Vanguard has one.)
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

@grabiner,

1) Even if you do donate to charity and thus the itemized deductions exceed the standard deduction, the tax savings would be attributable to the charitable donations and not to mortgage interest. We have had multiple instances of disagreement in the past on this point; I view the mortgage interest at the bottom of the pit with charitable deductions stacked on top it, and together they must exceed the pit height of standard deduction ... the piece poking above the standard deduction would then be the charitable deductions.

2) With the yield curve inverted, unless the poster is contemplating paying *OFF* the mortgage and not merely paying it down, short term rates are a good comparison tool. By investing in the short term treasuries and capturing the higher yield, the amount to pay DOWN the mortgage can be kicked out to a few months. So if there is $10k to either invest or pay down the mortgage, given that 3 month T-bills are yielding 5.25% or so, invest the $10k into 3-months Treasuries, capture the yield, and then at the end of the 3-months, re-evaluate.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by TheBOFH »

grabiner wrote: Sat Jun 10, 2023 9:18 pm The correct comparison is to a bond of the same duration. which would be a long-term bond, not a short-term bond. If you make an extra payment on the mortgage, you get a fixed amount of money in 27 years (or possibly earlier if you sell the house). If you buy a long-term bond, you also get a fixed amount of money when the bond matures.

But even that justifies investing in preference to paying off the mortgage early. Vanguard Extended-Duration Treasury ETF, which holds very-long-term zero-coupon Treasuries, currently yields 4.08%. A more likely comparison is Vanguard Long-Term Bond Index, with a 15-year duration and some corporate bonds; it yields 4.84%. I would prefer either of these funds to paying down a 2.75% mortgage in a 22% bracket. (And in a higher bracket, I would similarly prefer Vanguard Long-Term Tax-Exempt, or the long-term muni fund for your state if Vanguard has one.)
I'm struggling with a similar decision as the OP, and this post is the first time I've seen the length of available bonds taken into account as part of the discussion. I'd appreciate your feedback as to whether I am looking at and understanding things correctly based on your post.

2.75% mortgage, 27 years to go, owe just shy of $700K. Debating making a $400K payment and recasting the loan, while continuing to make the current payment so as to have the house paid off around when we retire.

Given our marginal tax rate, we need a 4.8% pre-tax return to break even and I don't see a way to do that for more than a year or so. Vanguard's NY Long-Term Tax Exempt fund (VNYUX) shows a 30 day yield of 3.66%. Since it's tax-exempt, I should be able to compare this directly to the 2.75% mortgage, right? The fund yield is 91 basis points higher than the mortgage, so on $400K, I'm looking at earning approximately $3640 extra versus paying down the mortgage. However, for that $3640 per year I'm taking on a non-zero degree of risk.

Am I missing anything?

Thanks!
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Beensabu »

Why would you do early payoff on 2.75%?

You can get 5% in money market funds right now.

Just put the extra money in a money market fund and revisit once yields drop below your mortgage rate.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

Beensabu wrote: Sat Jun 10, 2023 11:05 pm Why would you do early payoff on 2.75%?

You can get 5% in money market funds right now.

Just put the extra money in a money market fund and revisit once yields drop below your mortgage rate.
2.75% is after tax vs 5% being before tax. Now that may not change the conclusion (unless the poster is in California and 37% + 3.8% NIIT + 11.3% state tax rate), but the tax implications should not be ignored. It is not a straight comparison of the rates.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by Beensabu »

lakpr wrote: Sat Jun 10, 2023 11:34 pm
Beensabu wrote: Sat Jun 10, 2023 11:05 pm Why would you do early payoff on 2.75%?

You can get 5% in money market funds right now.

Just put the extra money in a money market fund and revisit once yields drop below your mortgage rate.
2.75% is after tax vs 5% being before tax. Now that may not change the conclusion (unless the poster is in California and 37% + 3.8% NIIT + 11.3% state tax rate), but the tax implications should not be ignored. It is not a straight comparison of the rates.
You're right.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

TheBOFH wrote: Sat Jun 10, 2023 11:02 pm 2.75% mortgage, 27 years to go, owe just shy of $700K. Debating making a $400K payment and recasting the loan, while continuing to make the current payment so as to have the house paid off around when we retire.

Given our marginal tax rate, we need a 4.8% pre-tax return to break even and I don't see a way to do that for more than a year or so. Vanguard's NY Long-Term Tax Exempt fund (VNYUX) shows a 30 day yield of 3.66%. Since it's tax-exempt, I should be able to compare this directly to the 2.75% mortgage, right? The fund yield is 91 basis points higher than the mortgage, so on $400K, I'm looking at earning approximately $3640 extra versus paying down the mortgage. However, for that $3640 per year I'm taking on a non-zero degree of risk.
I wonder if holding treasuries with no more than 6 months maturity would be better. State and local tax free, and 6 month T bills are yielding 5%+. You can revisit the pay down question 6 months later.

I would not commit to long term bonds in this environment.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by JBTX »

TheBOFH wrote: Sat Jun 10, 2023 11:02 pm
grabiner wrote: Sat Jun 10, 2023 9:18 pm The correct comparison is to a bond of the same duration. which would be a long-term bond, not a short-term bond. If you make an extra payment on the mortgage, you get a fixed amount of money in 27 years (or possibly earlier if you sell the house). If you buy a long-term bond, you also get a fixed amount of money when the bond matures.

But even that justifies investing in preference to paying off the mortgage early. Vanguard Extended-Duration Treasury ETF, which holds very-long-term zero-coupon Treasuries, currently yields 4.08%. A more likely comparison is Vanguard Long-Term Bond Index, with a 15-year duration and some corporate bonds; it yields 4.84%. I would prefer either of these funds to paying down a 2.75% mortgage in a 22% bracket. (And in a higher bracket, I would similarly prefer Vanguard Long-Term Tax-Exempt, or the long-term muni fund for your state if Vanguard has one.)
I'm struggling with a similar decision as the OP, and this post is the first time I've seen the length of available bonds taken into account as part of the discussion. I'd appreciate your feedback as to whether I am looking at and understanding things correctly based on your post.

2.75% mortgage, 27 years to go, owe just shy of $700K. Debating making a $400K payment and recasting the loan, while continuing to make the current payment so as to have the house paid off around when we retire.

Given our marginal tax rate, we need a 4.8% pre-tax return to break even and I don't see a way to do that for more than a year or so. Vanguard's NY Long-Term Tax Exempt fund (VNYUX) shows a 30 day yield of 3.66%. Since it's tax-exempt, I should be able to compare this directly to the 2.75% mortgage, right? The fund yield is 91 basis points higher than the mortgage, so on $400K, I'm looking at earning approximately $3640 extra versus paying down the mortgage. However, for that $3640 per year I'm taking on a non-zero degree of risk.

Am I missing anything?

Thanks!
I would think at least some of your mortgage interest would be tax deductible given the mortgage balance. I’d assume you have at least $10k in state and local taxes. Plus about $19k interest so you are at least at $29k, over standard deduction, plus any charitable contributions or other itemized deductions.

If you pay off a chunk, you will be paying off the tax deductible portion. At 2.75% I wouldn’t pay it off, deductible or not. You are getting $700k of liquidity for free, and likely making a few thousand a year on net interest gravy. You are being paid to hold cash. Why wouldn’t you?
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Re: Paying Off Mortgage vs Investing Extra Money

Post by tixoboy »

lakpr wrote: Sat Jun 10, 2023 9:50 pm @grabiner,
2) With the yield curve inverted, unless the poster is contemplating paying *OFF* the mortgage and not merely paying it down, short term rates are a good comparison tool. By investing in the short term treasuries and capturing the higher yield, the amount to pay DOWN the mortgage can be kicked out to a few months. So if there is $10k to either invest or pay down the mortgage, given that 3 month T-bills are yielding 5.25% or so, invest the $10k into 3-months Treasuries, capture the yield, and then at the end of the 3-months, re-evaluate.
I would caution that in implementing this approach as opposed to buying longer-duration bonds, you would be exposing yourself to reinvestment risk since the 3 month yield could drop, and that this risk is significant given the 28-year mortgage's long duration.

I think this post does a good job of explaining how duration impacts interest rate risk:
viewtopic.php?p=4755489#p4755489
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

tixoboy wrote: Sun Jun 11, 2023 2:31 am
lakpr wrote: Sat Jun 10, 2023 9:50 pm @grabiner,
2) With the yield curve inverted, unless the poster is contemplating paying *OFF* the mortgage and not merely paying it down, short term rates are a good comparison tool. By investing in the short term treasuries and capturing the higher yield, the amount to pay DOWN the mortgage can be kicked out to a few months. So if there is $10k to either invest or pay down the mortgage, given that 3 month T-bills are yielding 5.25% or so, invest the $10k into 3-months Treasuries, capture the yield, and then at the end of the 3-months, re-evaluate.
I would caution that in implementing this approach as opposed to buying longer-duration bonds, you would be exposing yourself to reinvestment risk since the 3 month yield could drop, and that this risk is significant given the 28-year mortgage's long duration.

I think this post does a good job of explaining how duration impacts interest rate risk:
viewtopic.php?p=4755489#p4755489
What reinvestment risk? If the yields drop at the end of the 3-month period, the option to pay down the mortgage is always there.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by tixoboy »

grabiner wrote: Sat Jun 10, 2023 9:18 pm
lakpr wrote: Sat Jun 10, 2023 9:00 pm
tixoboy wrote: Sat Jun 10, 2023 8:37 pm FWIW, my spouse has a mortgage exactly at 2.75% as well which ends October 2050 with about a $390k balance. If we "paid it off" today by building a US treasuries ladder with monthly maturity between now and October 2050 and use those maturing bonds to pay off the mortgage, it would cost ~$340-$350k (this ignores having to pay tax on the gains, so that also has to be factored in).
In this particular case, annual mortgage interest is $10,750; plus SALT deduction of maximum $10k would put the total itemized deductions at $20,750. This is less than standard deduction of $27,700 so that 2.75% rate is after tax.
Unless you donate a lot to charity, this is correct.
To earn a 2.75% after tax return you will need to earn 2.75% ÷ (1 - 22% - 5%) = 3.75% in a bond. 22% and 5% are assumed Federal and State tax brackets.

Given that short term treasuries are yielding 5%, the answer is to invest than pay extra on the mortgage.
The correct comparison is to a bond of the same duration. which would be a long-term bond, not a short-term bond. If you make an extra payment on the mortgage, you get a fixed amount of money in 27 years (or possibly earlier if you sell the house). If you buy a long-term bond, you also get a fixed amount of money when the bond matures.

But even that justifies investing in preference to paying off the mortgage early. Vanguard Extended-Duration Treasury ETF, which holds very-long-term zero-coupon Treasuries, currently yields 4.08%. A more likely comparison is Vanguard Long-Term Bond Index, with a 15-year duration and some corporate bonds; it yields 4.84%. I would prefer either of these funds to paying down a 2.75% mortgage in a 22% bracket. (And in a higher bracket, I would similarly prefer Vanguard Long-Term Tax-Exempt, or the long-term muni fund for your state if Vanguard has one.)
@grabiner, I think this comparison is correct, but I worry about equating a bond of the correct duration with a mortgage for two reasons.

(1) Bond ETFS are typically managed to achieve a relatively constant duration (~25 years for Vanguard Extended-Duration / ~15 years for Vanguard Long-Term Bond Index). The mortgage debt is constantly decreasing in duration, and so as time passes, were OP to pay off their mortgage with these funds, they'd need to somehow decrease the duration of their exposure to these bond ETFS. It's not clear to me how easy this is to do - in other threads I've read, the idea seems to be something like selling off a % of the ETF periodically (say every year).

(2) Holding a Bond ETF that contains of thousands of underlying bonds may not generate the same cash flow as what would actually be needed to pay off OP's mortgage, leading to cash flow problems. Since OP expects to continue paying their mortgage off in retirement, this problem could be significant in their later years.

What do you think?
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Re: Paying Off Mortgage vs Investing Extra Money

Post by tixoboy »

lakpr wrote: Sun Jun 11, 2023 2:38 am
tixoboy wrote: Sun Jun 11, 2023 2:31 am
lakpr wrote: Sat Jun 10, 2023 9:50 pm @grabiner,
2) With the yield curve inverted, unless the poster is contemplating paying *OFF* the mortgage and not merely paying it down, short term rates are a good comparison tool. By investing in the short term treasuries and capturing the higher yield, the amount to pay DOWN the mortgage can be kicked out to a few months. So if there is $10k to either invest or pay down the mortgage, given that 3 month T-bills are yielding 5.25% or so, invest the $10k into 3-months Treasuries, capture the yield, and then at the end of the 3-months, re-evaluate.
I would caution that in implementing this approach as opposed to buying longer-duration bonds, you would be exposing yourself to reinvestment risk since the 3 month yield could drop, and that this risk is significant given the 28-year mortgage's long duration.

I think this post does a good job of explaining how duration impacts interest rate risk:
viewtopic.php?p=4755489#p4755489
What reinvestment risk? If the yields drop at the end of the 3-month period, the option to pay down the mortgage is always there.
@lakpr, that's true - OP can always pay down the mortgage, but I believe it's possible that at the end of the 3-month period, interest rates could have fallen and more optimal bonds today would no longer be available. I'm not 100% sure that "reinvestment risk" is the right term here, but let me give an example that I think illustrates my thinking here and what I understand to be reinvestment risk. Tax implications are definitely significant, but I'd like to ignore it in the below just to get the idea across. Let's say that today, OP has two choices:

(1) Invest in 3 month T-bills yielding 5.25%, and then re-evaluate ~3 months. At any point, if yields are higher than 2.75%, invest in 3 month T-bills again. Otherwise, pay down the mortgage to get a 2.75% yield for the remaining duration of the mortgage.

(2) Invest in a 28-year T-bill yielding ~3.78%.

Option (1) is subject to "reinvestment risk" (again, not sure if this is really the way to use the term) relative to option (2) because interest rates could suddenly fall at any point in time, leading OP to yield only a 2.75% yield, which is low compared to option (2), since OP could lock in a 3.78% yield for the lifetime of the investment.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by tixoboy »

TheBOFH wrote: Sat Jun 10, 2023 11:02 pm
grabiner wrote: Sat Jun 10, 2023 9:18 pm The correct comparison is to a bond of the same duration. which would be a long-term bond, not a short-term bond. If you make an extra payment on the mortgage, you get a fixed amount of money in 27 years (or possibly earlier if you sell the house). If you buy a long-term bond, you also get a fixed amount of money when the bond matures.

But even that justifies investing in preference to paying off the mortgage early. Vanguard Extended-Duration Treasury ETF, which holds very-long-term zero-coupon Treasuries, currently yields 4.08%. A more likely comparison is Vanguard Long-Term Bond Index, with a 15-year duration and some corporate bonds; it yields 4.84%. I would prefer either of these funds to paying down a 2.75% mortgage in a 22% bracket. (And in a higher bracket, I would similarly prefer Vanguard Long-Term Tax-Exempt, or the long-term muni fund for your state if Vanguard has one.)
I'm struggling with a similar decision as the OP, and this post is the first time I've seen the length of available bonds taken into account as part of the discussion. I'd appreciate your feedback as to whether I am looking at and understanding things correctly based on your post.

2.75% mortgage, 27 years to go, owe just shy of $700K. Debating making a $400K payment and recasting the loan, while continuing to make the current payment so as to have the house paid off around when we retire.

Given our marginal tax rate, we need a 4.8% pre-tax return to break even and I don't see a way to do that for more than a year or so. Vanguard's NY Long-Term Tax Exempt fund (VNYUX) shows a 30 day yield of 3.66%. Since it's tax-exempt, I should be able to compare this directly to the 2.75% mortgage, right? The fund yield is 91 basis points higher than the mortgage, so on $400K, I'm looking at earning approximately $3640 extra versus paying down the mortgage. However, for that $3640 per year I'm taking on a non-zero degree of risk.

Am I missing anything?

Thanks!
It looks like VNYUX has an average duration of 7.4 years and stated maturity of 16.2 years, so I don't think it's directly comparable to your mortgage of 27 years since the durations are different. Even if they were the same, I have a hard time convincing myself that directly comparing them is the right thing to do - see my post above viewtopic.php?p=7306594#p7306594.

I'm starting to feel like the most optimal way to arbitrage low mortgage rates is to manually build a monthly ladder of zero-coupon treasuries until the mortgage is paid. That way, the duration, cash flow, and maturity of the purpose-build ladder is equivalent to the mortgage. That is A LOT of work though.... For a 27 year mortgage, that's buying something like bonds with 27*12 = 324 different maturity dates. Or maybe just every year since that's more tenable?
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

tixoboy wrote: Sun Jun 11, 2023 3:03 am @lakpr, that's true - OP can always pay down the mortgage, but I believe it's possible that at the end of the 3-month period, interest rates could have fallen and more optimal bonds today would no longer be available. I'm not 100% sure that "reinvestment risk" is the right term here, but let me give an example that I think illustrates my thinking here and what I understand to be reinvestment risk. Tax implications are definitely significant, but I'd like to ignore it in the below just to get the idea across. Let's say that today, OP has two choices:

(1) Invest in 3 month T-bills yielding 5.25%, and then re-evaluate ~3 months. At any point, if yields are higher than 2.75%, invest in 3 month T-bills again. Otherwise, pay down the mortgage to get a 2.75% yield for the remaining duration of the mortgage.

(2) Invest in a 28-year T-bill yielding ~3.78%.

Option (1) is subject to "reinvestment risk" (again, not sure if this is really the way to use the term) relative to option (2) because interest rates could suddenly fall at any point in time, leading OP to yield only a 2.75% yield, which is low compared to option (2), since OP could lock in a 3.78% yield for the lifetime of the investment.
Long term treasuries (actually any long term bonds) are subject to interest rate risk. If in the future the interest rates RISE instead of FALLing, then that 28 year Treasury Bond will lose value. So you will have traded "reinvestment risk" for "interest rate risk" instead.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by tixoboy »

lakpr wrote: Sun Jun 11, 2023 7:37 am
tixoboy wrote: Sun Jun 11, 2023 3:03 am @lakpr, that's true - OP can always pay down the mortgage, but I believe it's possible that at the end of the 3-month period, interest rates could have fallen and more optimal bonds today would no longer be available. I'm not 100% sure that "reinvestment risk" is the right term here, but let me give an example that I think illustrates my thinking here and what I understand to be reinvestment risk. Tax implications are definitely significant, but I'd like to ignore it in the below just to get the idea across. Let's say that today, OP has two choices:

(1) Invest in 3 month T-bills yielding 5.25%, and then re-evaluate ~3 months. At any point, if yields are higher than 2.75%, invest in 3 month T-bills again. Otherwise, pay down the mortgage to get a 2.75% yield for the remaining duration of the mortgage.

(2) Invest in a 28-year T-bill yielding ~3.78%.

Option (1) is subject to "reinvestment risk" (again, not sure if this is really the way to use the term) relative to option (2) because interest rates could suddenly fall at any point in time, leading OP to yield only a 2.75% yield, which is low compared to option (2), since OP could lock in a 3.78% yield for the lifetime of the investment.
Long term treasuries (actually any long term bonds) are subject to interest rate risk. If in the future the interest rates RISE instead of FALLing, then that 28 year Treasury Bond will lose value. So you will have traded "reinvestment risk" for "interest rate risk" instead.
Right, but OP wouldn't necessarily care that the 28 Treasury Bond has lost value as they could hold it until maturity to essentially "make the last mortgage payment," so the "interest rate risk" (I think actually "price risk" according to the definition) has been negated. The risk being negated doesn't mean that the OP couldn't have made more money with option (1), but just that the risk profile is different.

We might be arguing over the usage/perspectives on "risk" here, which might be less relevant for OP. Let me re-frame the two options here a bit:

Option (1) locks in a high short-term interest rate of unknown total duration, but at least 5.25% for 3 months, with a floor of 2.75% for any remaining time on the mortgage since OP could pay down the mortgage at any time. The drawback here is that OP could lock in a 28-year interest rate at 3.78% today. So, if interest rates fall, this option loses compared to option(2).

Option (2) locks down a lower, 3.78% interest rate for the length of the mortgage. The drawback here is that OP could potentially lose out on a higher interest rate over the lifetime of the mortgage using the "wait-and-see" approach of option(1). So, this option loses compared to option (1) if interest rates rise.

Would you agree with this characterization of the two options, @lakpr?

Which one is the right option? I think this is a matter of personal choice. Personally, I like option (2) because the total reward is known today whereas the total reward for option (1) is unknown (since interest rates in 3 months are unknown), but could be higher or lower than (2) with a floor at 2.75%.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by lakpr »

Yes, I think we are in agreement, I would agree with your latest post.

Personally, given the steep difference between the 5.25% for short term and 3.78% for 28 years, I would go for Option (1). One can reasonably forecast what their job situation will be for the next 3 months or 6 months, perhaps even 1 year and thus commit to hold to maturity; but to get yourself locked into 3.78% for a lifetime is just asking for trouble. Life happens in 28 years.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by grabiner »

tixoboy wrote: Sun Jun 11, 2023 2:42 am
grabiner wrote: Sat Jun 10, 2023 9:18 pm The correct comparison is to a bond of the same duration. which would be a long-term bond, not a short-term bond. If you make an extra payment on the mortgage, you get a fixed amount of money in 27 years (or possibly earlier if you sell the house). If you buy a long-term bond, you also get a fixed amount of money when the bond matures.
@grabiner, I think this comparison is correct, but I worry about equating a bond of the correct duration with a mortgage for two reasons.

(1) Bond ETFS are typically managed to achieve a relatively constant duration (~25 years for Vanguard Extended-Duration / ~15 years for Vanguard Long-Term Bond Index). The mortgage debt is constantly decreasing in duration, and so as time passes, were OP to pay off their mortgage with these funds, they'd need to somehow decrease the duration of their exposure to these bond ETFS. It's not clear to me how easy this is to do - in other threads I've read, the idea seems to be something like selling off a % of the ETF periodically (say every year).
The most fair comparison is to individual bonds. If you sell a 27-year zero-coupon bond to pay down your 27-year mortgage to 26 years, you don't change your risk profile at all. Likewise, if you sell a 27-year bond ladder to pay off your 27-year mortgage, you don't change your risk profile.

If you choose not to hold these specific bonds, then you are presumably making a fair trade-off between risk and return. You could take less interest-rate risk with shorter-duration bonds, and more credit risk with lower-quality bonds, Thus a bond fund of similar duration is a good comparison, and these are usually more convenient for investors.

If you do want to continue to duration match with bond funds, you can change your portfolio annually, selling some of your longer-term bond fund to buy a shorter-term fund every year, until you have an ultrashort fund or money-market fund in the last year.
(2) Holding a Bond ETF that contains of thousands of underlying bonds may not generate the same cash flow as what would actually be needed to pay off OP's mortgage, leading to cash flow problems. Since OP expects to continue paying their mortgage off in retirement, this problem could be significant in their later years.
You would need to sell some of the bond funds to make the mortgage payments. But you would be doing the same thing with individual bonds; if you buy a bond ladder to make every year's mortgage payment, then you cash in one bond maturing every year and use the principal for mortgage payments rather than reinvesting the maturing bond.
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Re: Paying Off Mortgage vs Investing Extra Money

Post by grabiner »

lakpr wrote: Sun Jun 11, 2023 2:38 am
tixoboy wrote: Sun Jun 11, 2023 2:31 am
lakpr wrote: Sat Jun 10, 2023 9:50 pm @grabiner,
2) With the yield curve inverted, unless the poster is contemplating paying *OFF* the mortgage and not merely paying it down, short term rates are a good comparison tool. By investing in the short term treasuries and capturing the higher yield, the amount to pay DOWN the mortgage can be kicked out to a few months. So if there is $10k to either invest or pay down the mortgage, given that 3 month T-bills are yielding 5.25% or so, invest the $10k into 3-months Treasuries, capture the yield, and then at the end of the 3-months, re-evaluate.
I would caution that in implementing this approach as opposed to buying longer-duration bonds, you would be exposing yourself to reinvestment risk since the 3 month yield could drop, and that this risk is significant given the 28-year mortgage's long duration.

I think this post does a good job of explaining how duration impacts interest rate risk:
viewtopic.php?p=4755489#p4755489
What reinvestment risk? If the yields drop at the end of the 3-month period, the option to pay down the mortgage is always there.
The option to pay down remains. However, the inverted yield curve makes it more likely that the option to invest instead will have a lower return.

The current yield on 1-year Treasury bonds is 5.17%, and the current yield on 30-year Treasuries is 3.89%. A 30-year Treasury has about a 20-year duration. Thus, if the yield drops to 3.74% next year, the Treasury will increase in value by 3%; that is a reasonable expectation for the risk premium.

So, if that is what happens to the market, you can invest in a 1-year Treasury and earn 5.17%, then reinvest in a 29-year Treasury yielding 3.74%. Alternatively, you could invest in a 30-year Treasury which returns 6.89% over the next year, and then have a 29-year Treasury yielding 3.74%. If you are matching a long-term liability, the second option looks more attractive.

And if you do intend to pay down next year, you may still prefer an expected 6.89% in a long-term bond over a certain 5.17% in a short-term bond. The interest-rate risk of the long-term bond doesn't hurt you as much, as if rates rise enough that the long-term bond now yields more than your mortgage, you don't need to sell the bond.
Wiki David Grabiner
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