Go full in or pay off mortgage?

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Go full in or pay off mortgage?

Post by Matthew19 » Sat Jun 13, 2015 10:17 pm

I've read the old posts on this topic, but I'd love to know more about the pros and cons of paying off the mortgage. I have 750k liquid and owe 189k on a 4% mortgage. Bankrate has a nice calculator which gave me an effective rate of 2.8% after mortgage interest deductions. So it's a guaranteed 2.8% with a payoff or a possible 4-5% plus taxes with the HBPP.
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Re: Go full in or pay off mortgage?

Post by whatchamacallit » Sat Jun 13, 2015 10:57 pm

I rent so my ideas may not hold much weight but here are some thoughts.


Pros:

The guaranteed 2.8% return

You won't be leveraged ( this can be a pro or con depending on the market but it feels like more of a pro for me )

Cons:

Do you have to pay taxes to get the 189k for the payoff?

You probably already paid fees to get into the mortgage. Since you are already there, you might as well take advantage of the cheap leverage. Otherwise you are wasting these fees.
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Re: Go full in or pay off mortgage?

Post by KevinW » Sat Jun 13, 2015 11:52 pm

If I woke up in that situation I'd pay off the mortgage in full.

There is a big difference, both mathematically and emotionally, between 2.8% guaranteed and 4-5% (I would actually say 3-5% for the PP, but whatever). Good luck finding zero-risk 2.8% after-tax returns anywhere else in the current interest rate environment.

There is an intangible emotional benefit to having no debts, and to be able to conduct all your financial transactions on a for-profit or break-even basis.
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Re: Go full in or pay off mortgage?

Post by barrett » Sun Jun 14, 2015 7:08 am

KevinW wrote: There is an intangible emotional benefit to having no debts, and to be able to conduct all your financial transactions on a for-profit or break-even basis.
I love being debt free but then I find that I can't talk about it with anyone except my wife (Chinese people seem to hate debt). Maybe a few other people but most friends just assume that we have a mortgage. This is not a huge deal obviously but I do notice it. I guess the best way I can put it is that not having a mortgage seems to exclude you from commiseration conversations about other expenses (property taxes, retirement needs, high education costs, etc.).

Some people seem really comfortable carrying a mortgage for 30 years. It would drive me crazy. If you are comfortable with it, it sounds like you have a good interest rate locked in. You said in an earlier post that you are only 32 years old so it will be paid off earlier than most anyway.
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Re: Go full in or pay off mortgage?

Post by ochotona » Sun Jun 14, 2015 8:01 am

Pay it off before your oldest child goes to college
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Re: Go full in or pay off mortgage?

Post by Pointedstick » Sun Jun 14, 2015 8:55 am

Like Kevin, I would pay it off as well were I in that situation, especially if I could do it without incurring any capital gains taxes on the withdrawn investment money. With $750k in financial assets, you'd still have plenty of liquidity even after paying off the mortgage.
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Re: Go full in or pay off mortgage?

Post by MachineGhost » Sun Jun 14, 2015 10:02 am

Everyone here seems to be focusing on emotional needs. 

I say don't forget to consider the future impact of inflation whittling down the real value of the mortgage and payments as well as the increase in the real equity.  It may or may not be a better deal than paying it off and investing it in the PP.
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Re: Go full in or pay off mortgage?

Post by Matthew19 » Sun Jun 14, 2015 10:10 am

There would be no capital gains tax that I'd have to pay to get the money.
I understand that  a high inflation environment would be a plus to carrying a mortgage. But that assumes that the PP makes larger gains than the inflation rate, then I pay 30% tax on those gains. What was the PP actual rate through the 70's?
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Re: Go full in or pay off mortgage?

Post by barrett » Sun Jun 14, 2015 10:45 am

Matthew19 wrote: What was the PP actual rate through the 70's?
A good place to check out real rolling rates is page 25 of the PP book, but the short answer is that the PP did way better than a 60/40 mix (but about the same as it always has... that is 3-6% real). Many will argue that that is because gold's rise in the 1970s is not a repeatable event.

Are any of your accounts tax advantaged? If so, I wouldn't assume a 30% tax rate. Much of that money will be taken out when you are older and in a lower bracket (well, we hope that is the case!). Also, there is not a lot of buying and selling in the PP which makes it quite tax efficient.

The other thing is that with $750,000 liquid at age 32, we are soon going to be asking you for advice. Just sayin'.
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Re: Go full in or pay off mortgage?

Post by Tyler » Sun Jun 14, 2015 2:42 pm

Matthew19 wrote: I've read the old posts on this topic, but I'd love to know more about the pros and cons of paying off the mortgage. I have 750k liquid and owe 189k on a 4% mortgage. Bankrate has a nice calculator which gave me an effective rate of 2.8% after mortgage interest deductions. So it's a guaranteed 2.8% with a payoff or a possible 4-5% plus taxes with the HBPP.
FWIW -- 66% of people take the standard deduction, making the mortgage interest deduction irrelevant.  A lot of those calculators are deceiving, so make sure it applies you you.  The results may look even better than that.

Personally, my general rule of thumb that I wish I would have come up with when I was younger is to maintain your home equity (based on the mortgage amount, not subsequent price changes) at about 20% of your net worth.  So assuming you put 20% down, don't buy a house you couldn't afford to buy in cash if you wanted to. And when the original mortgage is less than 20% of your net worth, go ahead and pay it off.  You can sorta think of it as a 5th equal leg of your personal Permanent Portfolio.

This system allows you to stay well-invested and your wealth diversified away from your home.  But once your remaining principal is small relative to your other investments, the marginal benefit of keeping the mortgage becomes pretty small as well. 

You're pretty close to that line as-is, so it's your call.  A lot of it comes down to your personal goals.  Having no debt mitigates natural financial uncertainty, which can be a great aid in planning for things like college for the kids or early retirement. 
Last edited by Tyler on Mon Jun 15, 2015 1:09 am, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by Desert » Sun Jun 14, 2015 7:08 pm

barrett wrote:
Matthew19 wrote: What was the PP actual rate through the 70's?
A good place to check out real rolling rates is page 25 of the PP book, but the short answer is that the PP did way better than a 60/40 mix (but about the same as it always has... that is 3-6% real). Many will argue that that is because gold's rise in the 1970s is not a repeatable event.

Are any of your accounts tax advantaged? If so, I wouldn't assume a 30% tax rate. Much of that money will be taken out when you are older and in a lower bracket (well, we hope that is the case!). Also, there is not a lot of buying and selling in the PP which makes it quite tax efficient.

The other thing is that with $750,000 liquid at age 32, we are soon going to be asking you for advice. Just sayin'.
+1!  :)

I'd pay it off, by the way.  TN and Tyler's point regarding standard deduction is a very good one. I don't know if you have an escrow now, but it's nice to be rid of that as well. A few percent of risk free return is great, if you're a conservative investor. 

Another way some folks look at it:  Would you get a HELOC and invest the proceeds in the PP (or portfolio of your choice)?  In other words, would you borrow money to invest in risky assets?  If not, you should pay off the mortgage. 
Last edited by Desert on Sun Jun 14, 2015 7:11 pm, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by sophie » Sun Jun 14, 2015 8:08 pm

Tyler wrote: Personally, my general rule of thumb that I wish I would have come up with when I was younger is to maintain your home equity (based on the mortgage amount, not subsequent price changes) at about 20% of your net worth.  So assuming you put 20% down, don't buy a house you couldn't afford to buy in cash if you wanted to. And when the original mortgage is less than 20% of your net worth, go ahead and pay it off.  You can sorta think of it as a 5th equal leg of your personal Permanent Portfolio.
Interesting guideline that most of us are probably violating.  Could you elaborate on the rationale?

By this guideline, someone with a $500K home, which in some cities/locales is quite modest, would need to aim for $2M in liquid savings before paying off the mortgage.  That seems rather high to me.
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Re: Go full in or pay off mortgage?

Post by Pointedstick » Sun Jun 14, 2015 9:00 pm

sophie wrote:
Tyler wrote: Personally, my general rule of thumb that I wish I would have come up with when I was younger is to maintain your home equity (based on the mortgage amount, not subsequent price changes) at about 20% of your net worth.  So assuming you put 20% down, don't buy a house you couldn't afford to buy in cash if you wanted to. And when the original mortgage is less than 20% of your net worth, go ahead and pay it off.  You can sorta think of it as a 5th equal leg of your personal Permanent Portfolio.
Interesting guideline that most of us are probably violating.  Could you elaborate on the rationale?

By this guideline, someone with a $500K home, which in some cities/locales is quite modest, would need to aim for $2M in liquid savings before paying off the mortgage.  That seems rather high to me.
Or maybe it highlights the insanity of playing many regional real estate markets as a member of the middle class. :)
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Re: Go full in or pay off mortgage?

Post by Tyler » Sun Jun 14, 2015 9:25 pm

sophie wrote: Interesting guideline that most of us are probably violating.  Could you elaborate on the rationale?

By this guideline, someone with a $500K home, which in some cities/locales is quite modest, would need to aim for $2M in liquid savings before paying off the mortgage.  That seems rather high to me.
Thanks for asking.  My original explanation was kinda clunky and I even messed it up a place or two.

To be clear, I don't fault anyone for paying off their mortgage at any time.  If you can afford to do that, I'm confident you're pretty good with money.  ;)  It's more about setting a max you can afford, taking a balanced approach to liquidity vs. equity, and recognizing a baseline where you can stop pretending that the mortgage is helping anything.

1) Don't take on more debt than you can afford to pay off if you need to.  That sets the max allowable home price at your net worth, and at 20% down puts your home equity at 20% of your NW.  If you want to put more down, that's great.

2) Stay flexible and don't over-commit to any one asset (including your house).  From a PP philosophy perspective I kinda like the 20% level as being "equal" to the other four assets.  Even though the house is not an investment, it is certainly has value and is a diversification tool for your financial assets.  But every person's opinion on the best percentage may differ here in the middle.

3) Know when to stop playing.  If I found out Warren Buffett just refinanced into a new 30-year mortgage to free up some cash, I'd confidently conclude he has lost touch with reality.  Even a large mortgage would be so small compared to his net worth that the deal wouldn't change his finances one iota.  The marginal financial utility of keeping a mortgage decreases as it shrinks relative to your net worth.  The cutoff point is up for debate, but IMHO the purchase price hitting the same 20% mark is a pretty good signal to consider paying off any remaining principal and embracing a debt-free life.

So that's where I got 20-20-20.  Please note that I definitely do not promote getting a more expensive house just to keep it at 20%.  The far more important thing financially is to buy the smallest and least expensive house where you will be happy!

I hear what you're saying about home prices in some urban centers, but IMHO average house price in a market is irrelevant to whether buying one is the best financial decision for you personally.  Sometimes it is wise to split from the herd. 

(Edited for brevity)
Last edited by Tyler on Mon Jun 15, 2015 1:11 am, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by Matthew19 » Mon Jun 15, 2015 12:15 am

I have 25 years left on the mortgage, so I I gut not be getting a big deduction. I'll have to check.

Tyler, great tips. The 20% rule does feel about right.
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Re: Go full in or pay off mortgage?

Post by barrett » Mon Jun 15, 2015 6:54 am

sophie wrote:
Tyler wrote: Personally, my general rule of thumb that I wish I would have come up with when I was younger is to maintain your home equity (based on the mortgage amount, not subsequent price changes) at about 20% of your net worth.  So assuming you put 20% down, don't buy a house you couldn't afford to buy in cash if you wanted to. And when the original mortgage is less than 20% of your net worth, go ahead and pay it off.  You can sorta think of it as a 5th equal leg of your personal Permanent Portfolio.
Interesting guideline that most of us are probably violating.  Could you elaborate on the rationale?

By this guideline, someone with a $500K home, which in some cities/locales is quite modest, would need to aim for $2M in liquid savings before paying off the mortgage.  That seems rather high to me.
I love the 20% rule for real estate. My personal goal is 15% but the reasons are the same. At 20% you have a good balance between investable assets and a place to live that isn't beyond your means.

Sophie, keep in mind that Tyler is talking about your mortgage being 20% of your NW, not the total value of your home. Hopefully he'll correct me if I am wrong about that.

In any event I think this should only be thought of as a guideline. In Manhattan and some other major cities, having a home that is a higher percentage of one's NW can make a lot of sense if it brings commute time and costs way down. And in my experience an apartment doesn't have nearly as many recurring costs as a free-standing home in the burbs. Plus, if it keeps you closer to friends and cultural activities (assuming those are things you are interested in), you don't have to spend a lot of time and money accessing those things.

The way I look at it, having a home that is a really high percentage of one's NW means that you are always tilted more toward inflation & prosperity. I'd be curious if others agree on that point.

Lastly, you don't always have to live in "the city." People do seem to have a hard time leaving but pulling a bunch of equity out of your home at some point (and going to rent a room from PS in New Mexico) is always a possibility.
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Re: Go full in or pay off mortgage?

Post by Libertarian666 » Mon Jun 15, 2015 9:09 am

The biggest issue I haven't seen addressed here is whether your mortgage is recourse or non-recourse.

A non-recourse mortgage, such as the one I have, includes a free put option on my house, to the extent of the mortgage.

That is, if there is a tremendous real estate crash, I can give the house back to the mortgage company and walk away with the only cost being a hit to my credit rating.

As long as I ignore my theoretical "home equity" as part of my portfolio (which is what I do in my spreadsheet), this enables me to avoid worrying about the possibility of a real estate crash (deflation) as far as my portfolio value is concerned. But I still get the inflation protection of having a negative $ balance overall, because if the $ is wiped out I get the house free and clear.

So I'm in absolutely no rush to pay off my 2.625% 15-yearmortgage, which has 13 years left to run.

If my mortgage had recourse provisions, then I would have to re-analyze this, as it would be far more dangerous to have a mortgage in that case.

If this isn't clear enough, I'll be happy to explain further.
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Re: Go full in or pay off mortgage?

Post by Pointedstick » Mon Jun 15, 2015 10:50 am

barrett wrote: Lastly, you don't always have to live in "the city." People do seem to have a hard time leaving but pulling a bunch of equity out of your home at some point (and going to rent a room from PS in New Mexico) is always a possibility.
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Re: Go full in or pay off mortgage?

Post by Tyler » Mon Jun 15, 2015 11:31 am

barrett wrote: Sophie, keep in mind that Tyler is talking about your mortgage being 20% of your NW, not the total value of your home. Hopefully he'll correct me if I am wrong about that.
To be precise, I actually mean home equity, ignoring price fluctuations after the purchase. That's where I stick to HB's mantra that a home is not an investment.  Sure you may sell your home for a profit later, but don't build your finances around that expectation.

When you first buy a home equal to your net worth, with 20% down your equity is 20% of your NW.  If your NW is more than the purchase price, put down extra so that your equity is 20% of your NW.  When your original purchase price is 20% of your NW and you pay it off, your equity is 20% of your NW.  Staying sorta near the 20% line in the meantime is a rough guide to the question "how much should I pre-pay on my mortgage?".  That said, I do not recommend taking money out of the house to invest should the percentages ever swing that way.

So yes, following this rule a person would pay off a $500k house when their net worth hits $2.5mm.  But that's more of a guideline to tell you to stop already rather than something you should necessarily wait for.  If you already have enough liquid money for your needs, paying off your debt before that is just fine. 
Libertarian666 wrote: The biggest issue I haven't seen addressed here is whether your mortgage is recourse or non-recourse.

A non-recourse mortgage, such as the one I have, includes a free put option on my house, to the extent of the mortgage.

That is, if there is a tremendous real estate crash, I can give the house back to the mortgage company and walk away with the only cost being a hit to my credit rating.
Sure.  That makes sense.

Any risk evaluation comes down to one's perception of consequences.  No recourse does not mean no consequences.  I personally would prefer to avoid the consequences of defaulting on a mortgage.  Beyond making it impossible to get a new loan for a good while, many employers these days look at your credit in the screening process.  My wife could have lost her security clearance with a mark like that as it represents a risk someone could influence her with money, greatly affecting her career opportunities.  Everyone has different priorities in life, but when giving general advice I tend to keep it on the side of safety. 
Last edited by Tyler on Mon Jun 15, 2015 12:16 pm, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by Libertarian666 » Mon Jun 15, 2015 12:12 pm

Tyler wrote:
barrett wrote: Sophie, keep in mind that Tyler is talking about your mortgage being 20% of your NW, not the total value of your home. Hopefully he'll correct me if I am wrong about that.
To be precise, I actually mean home equity, ignoring price fluctuations after the purchase. That's where I stick to HB's mantra that a home is not an investment.  Sure you may sell your home for a profit later, but don't build your finances around that expectation.

When you first buy a home equal to your net worth, with 20% down your equity is 20% of your NW.  If your NW is more than the purchase price, put down extra so that your equity is 20% of your NW.  When your original purchase price is 20% of your NW and you pay it off, your equity is 20% of your NW.  Staying sorta near the 20% line in the meantime is a rough guide to the question "how much should I pre-pay on my mortgage?".  That said, I do not recommend taking money out of the house to invest should the percentages ever swing that way.

So yes, following this rule a person would pay off a $500k house when their net worth hits $2.5mm.  But that's more of a guideline to tell you to stop already rather than something you should necessarily wait for.  If you already have enough liquid money for your needs, paying off your debt before that is just fine. 
Libertarian666 wrote: The biggest issue I haven't seen addressed here is whether your mortgage is recourse or non-recourse.

A non-recourse mortgage, such as the one I have, includes a free put option on my house, to the extent of the mortgage.

That is, if there is a tremendous real estate crash, I can give the house back to the mortgage company and walk away with the only cost being a hit to my credit rating.
Sure.  That makes sense.

Any risk evaluation comes down to one's perception of consequences.  No recourse does not mean no consequences.  I personally would prefer to avoid the consequences of defaulting on a mortgage.  Beyond making it impossible to get a new loan for a good while, many employers these days look at your credit in the screening process.  My wife could have lost her security clearance with a mark like that as it represents a risk someone could influence her with money, greatly affecting her career opportunities.  Everyone has different priorities in life, but when giving general advice I tend to keep it on the side of safety.
I think I should clarify that I have absolutely no intention of defaulting on my mortgage, nor have I had even one late payment.

But following the HBPP philosophy of taking precautions against unlikely events that can have catastrophic consequences, I like having a "put option" that provides protection against getting clobbered in a housing crash.
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Re: Go full in or pay off mortgage?

Post by Tyler » Mon Jun 15, 2015 12:20 pm

Understood!  And my advice is honestly intended more towards the mortgage crowd who sometimes borrows too much and doesn't know how to balance their debt properly or when to quit.  I'd wager most people here are pretty good with money and aren't the major risk-taking type.  ;)
Last edited by Tyler on Mon Jun 15, 2015 12:25 pm, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by dragoncar » Mon Jun 15, 2015 12:28 pm

TennPaGa wrote:
Tyler wrote:
Matthew19 wrote: I've read the old posts on this topic, but I'd love to know more about the pros and cons of paying off the mortgage. I have 750k liquid and owe 189k on a 4% mortgage. Bankrate has a nice calculator which gave me an effective rate of 2.8% after mortgage interest deductions. So it's a guaranteed 2.8% with a payoff or a possible 4-5% plus taxes with the HBPP.
FWIW -- 66% of people take the standard deduction, making the mortgage interest deduction irrelevant.  A lot of those calculators are deceiving, so make sure it applies you you.  The results may look even better than that.
This is a great point.  Putting some numbers to it...

If you owe $189,000 at 4% over 30 years, you'll pay $7500 in interest the first 12 months.  This is not much more than the standard deduction for a single person ($6,300), and less than the standard deduction for married filing jointly ($12,600).

Of course, the interest you pay over any 12 month period will decrease over the life of the loan.  If the length of the mortgage is less than 30 years, you'll pay less interest over any given 12 month period than you would with a 30 year.

Image
But this also ignores other deductions.  I agree everyone has to run the numbers themselves.  Depending on your state, income, and assessed he value, state income and property taxes can easily get you above the standard deduction.  A lot of people make charitable donations too.
Last edited by dragoncar on Mon Jun 15, 2015 5:36 pm, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by Tyler » Mon Jun 15, 2015 3:21 pm

Absolutely -- each person needs to evaluate their own situation.

Just going by the data, though, 66% of households in the US own their home while only 34% itemize.  And some high-income renters itemize as well.  So the mortgage interest deduction affects less than half of homebuyers, and is skewed towards expensive, high-tax areas like California.  Most websites and realtors use it as a default assumption because they are pushing mortgages, not because it reflects middle class behavior.
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Re: Go full in or pay off mortgage?

Post by screwtape » Mon Jun 15, 2015 8:00 pm

I have about a $200k mortgage at 4.25% and close to $1m in the PP nearing retirement.

No way I am going to pay off the mortgage. If I intended to live in the house during my retirement years I might think differently but I have no such intention right now. I want the money. Screw the house. Right now I'm thinking I can probably rent out the house and it'll be a wash on the balance sheet.

But really, it's to each his own. More than other investing forums, like Bogleheads, I think PPer's get that.
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Re: Go full in or pay off mortgage?

Post by Matthew19 » Mon Jun 15, 2015 9:37 pm

madbean2 wrote: I have about a $200k mortgage at 4.25% and close to $1m in the PP nearing retirement.

No way I am going to pay off the mortgage. If I intended to live in the house during my retirement years I might think differently but I have no such intention right now. I want the money. Screw the house. Right now I'm thinking I can probably rent out the house and it'll be a wash on the balance sheet.

But really, it's to each his own. More than other investing forums, like Bogleheads, I think PPer's get that.
So we are in a similar situation but it's clear cut for you? How long have you had your PP?
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