Go full in or pay off mortgage?

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Re: Go full in or pay off mortgage?

Post by sophie » Mon Jun 15, 2015 10:07 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. 
Ah, it's 20% of net worth you're talking about - I read it as "liquid assets" instead.  As far as counting house value as net worth:  I do think it's fair to reckon current value, as long you discount it about 8-10% to account for closing costs.  Certainly that's true if you plan to sell.

I think it really depends on your situation though.  I agree that if you're not itemizing deductions, it makes little sense to keep a mortgage unless the interest rate is lower than, say, the prime rate.  In my high tax situation, the deductions make the mortgage worthwhile (much as I hate the idea), but the first thing I plan to do when I retire is pay it off.
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Re: Go full in or pay off mortgage?

Post by Tyler » Mon Jun 15, 2015 10:33 pm

For sure.  No random rule of thumb on a message board should substitute for making well-informed decisions with your own money!  It's just a starting point for discussion.  Every situation is different. 

For the record, our first house was probably around 4x our net worth when we bought it.  I was laid off, sold the house, and moved for a great new job just before the housing crash.  Close call.

Our current house was just over 20% of our net worth when we bought it.  I was really tempted to pay cash, but I got a mortgage to keep options open and buy some time to sort out the early retirement plan.  By the time we paid it off a few years later it was less than that.  I really don't miss it. 
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Re: Go full in or pay off mortgage?

Post by EdwardjK » Tue Jun 16, 2015 6:43 am

Perhaps I have a different perspective than others.

I am recently retired and currently have a 30-year mortgage with a 3% interest rate for the first 10 years.  This is courtesy of my mortgage company that provided a no-cost refinance with an interest rate lower than my father's mortgage from 1964.  Although I do have the ability to pay off the mortgage, I choose to keep it because I believe that I can earn more on the money than my 3% interest rate.

There is also the potential that I may need the cash used to pay off the mortgage at some point in the future. 

Having said that, I expect to pay off the mortgage balance by the end of the first 10 years.  The interest rate will adjust and I expect interest rates to be higher then than they are currently.

This approach ensures that I have available cash should I need it as I adjust to retirement life.  But once I settle in, then yes, I plan to pay off the mortgage.
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Re: Go full in or pay off mortgage?

Post by moda0306 » Tue Jun 16, 2015 9:33 am

EdwardjK wrote: Perhaps I have a different perspective than others.

I am recently retired and currently have a 30-year mortgage with a 3% interest rate for the first 10 years.  This is courtesy of my mortgage company that provided a no-cost refinance with an interest rate lower than my father's mortgage from 1964.  Although I do have the ability to pay off the mortgage, I choose to keep it because I believe that I can earn more on the money than my 3% interest rate.

There is also the potential that I may need the cash used to pay off the mortgage at some point in the future. 

Having said that, I expect to pay off the mortgage balance by the end of the first 10 years.  The interest rate will adjust and I expect interest rates to be higher then than they are currently.

This approach ensures that I have available cash should I need it as I adjust to retirement life.  But once I settle in, then yes, I plan to pay off the mortgage.
For me it's less about the thinking that I can get a higher rate of return on my money than the idea that even if I lose half a percent to debt by investing in the safe bond market, liquidity and flexibility with my balance sheet.

There are so many more situations where you are in a far-worse position with paid-down debt than with a more robust balance-sheet arrangement.

A disability event, even with proper disability insurance, can be an absolute nightmare from a financial standpoint.


We've gone through this in a different thread, but while debt can be very toxic behaviorally, mathmatically, it's usually the PURCHASE associated with the debt that makes it so bad.  For instance, if I were to borrow $200,000 @ 5% and just invest it at 3%, the drain on that would be $4,000 in net cost to me per year, with the ability to always pay it back.

However, if I drop $200,000 on an education that will get me no-better a job than someone out of highschool, from an economic standpoint, I lost that $200,000 to a lifestyle/mental-stimulation decision.  If I use that debt to purchase a house, with 3% CC's on the front end and 6.5% realtor fees on the back, and huge operating expenses along the way and a RoR on value that will slightly lag inflation (once you account for house size, homes have actually lagged inflation), then you can see how while that may not be a complete waste of money, you've put yourself in a FAR more precarious position than just a cost of $4,000 per year that can be eliminated on a whim.

So debt isn't the problem.  Our purchases are.  Debt is just the tool that allows all the rationalization in the world to happen and result in gross overspending, and when people feel poor at the end of the first two years of owning an "investment" like a home, and they see that mortgage payment come due again, they rationalize it as the "debt" being the problem.

If people would analyze their purchases from a business-like standpoint, rather than that of a consumer who has a rush of enthusiasm, then they'd see that debt, properly utilized, is a phenomenal tool... it's just far-too-often used on the wrong things, or the "right" things, generally, but taken to such excess that they become more consumption than investment.

This is part of the reason that I think a lot of people who choose to get a fancy car a couple years out of college are possibly not making as poor a decision as the guy who buys a house, doesn't rent it to any buddies, and doesn't need the 4 BR 2 car garage, and therefore could have been renting a bedroom somewhere or splitting a 2 BR apartment with a friend.  Especially if that doesn't end up being the house he raises a family in, so he ends up paying a realtor to sell it for him and re-pays CC's on a new place.

Keep in mind, I am NOT saying the following:

- Buying a modest home with space you value in a good neighborhood/district is a BAD decision.
- Getting an education to advance a real career is a bad decision.
- Using debt to buy a reliable vehicle that meets your utilitarian needs is a bad decision.




Oh and don't have kids... financial decision #1!  :)
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Re: Go full in or pay off mortgage?

Post by Pointedstick » Tue Jun 16, 2015 9:55 am

moda0306 wrote: If I use that debt to purchase a house, with 3% CC's on the front end and 6.5% realtor fees on the back, and huge operating expenses along the way and a RoR on value that will slightly lag inflation (once you account for house size, homes have actually lagged inflation), then you can see how while that may not be a complete waste of money, you've put yourself in a FAR more precarious position than just a cost of $4,000 per year that can be eliminated on a whim.
But the mortgaged house still has the same running cost and inflation-lagging market value as the un-mortgaged house. And because of the mortgage, there is less monthly cashflow available to deal with the unexpected costs of home ownership. If one really wants to have maximum financial flexibility, the correct solution is not to buy at all, and rent instead.

When it comes to home ownership, I think for financially savvy people, here are the rules:

1. Only buy a house if you are handy and like home maintenance/improvement
2. Only buy a house you could pay cash for if you wanted to; beyond that, get a mortgage if you want, no biggie
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Re: Go full in or pay off mortgage?

Post by moda0306 » Tue Jun 16, 2015 10:13 am

PS,

I agree that there are tons of other on-going homeownership costs.  In fact I did some math the other day and if you have a 30 year mortgage, based on some standard assumptions, your total nominal cash-flow cost of ownership at year 31 will be higher than in year 1 due to inflation of the other costs of ownership (I think I used 3% inflation).

I agree that renting is best for max flexibility, but if one is going to own they are going to put themselves in a better position to handle ALL costs in an emergency by having liquidity rather than trying to pay down a mortgage.  Even if they successfully pay it off completely (let's say they take $50k to pay it off once and for all).  That's $50k that could have been used to make the payments going forward, pay off the debt, OR handle any number of additional cash-flow items.  Eliminating a low-interest debt related cash-flow doesn't ever, in any math that I've seen, match the cash-flow benefits of having the liquidity/options on your balance-sheet to address ALL cash-flow needs.

I think people are losing the forest through the trees on this.  If I have a $50k mortgage with 3 of 30 years remaining with a $1,500 per month payment and a 4% cost of capital (before any potential tax-benefits), I'm in a far better position to have the $50k to service that debt and/or any other CF requirements over the next few years than paying off the debt.

Now suppose I saved well and have a bunch of retirement funds ready to go, diversified, in multiple accounts.  One could argue at this point it's a moot point (and I'd be inclined to pretty much agree).  But even then, if we have an emergency pop up, anything we can do to give ourselves flexibility with our balance sheet or cash-flows is a good thing.  Any cash I can access is an equity position I don't have to liquidate if a market crash ensues.  Any positioning I don't have to give up today is positioning I've retained for any future event.

In these scenarios though, you won't find me beating that drum... just pay it off if it feels better.  It could be arguably safer from creditors.



I think there are plenty scenarios where you can show that owning = better than renting from a RoR mindset.  If you have 2-4 kids at home, and renting an apartment doesn't work, your ownership of a modest home could make a ton of sense.  Even if you're not handy, hiring it out could work into the numbers and still warrant the purchase.

But again... all this is independent of debt.  Adding debt to a good scenario usually makes it better.  Adding debt to a bad scenario usually makes it worse. 

A lot of this sort off gets to a point where the natural question might be, "what should your financial position look like before you have kids," but that's sort of an uncomfortable one to have, so we move from that to other topics around it.
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Re: Go full in or pay off mortgage?

Post by screwtape » Tue Jun 16, 2015 10:51 am

Matthew19 wrote:
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?
Been using the PP about 5 years now. Wish I'd started sooner.

Yes, it's clear cut to me. I can't imagine a situation where I'd ever pay off the mortgage but that's just my preference. I never planned to make it my retirement home any way so that's a big factor in the equation. May pay cash for another home down the road, however, if I am able to get rid of this one.
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Re: Go full in or pay off mortgage?

Post by dragoncar » Tue Jun 16, 2015 1:32 pm

Moda, what numbers do you use for maintenance?  I've seen rules thrown around like 2%/year but in my area that is unreasonably high (since s much value is in land).  Perhaps 2% of the structure value?  Yes I know I should do some kind of intensive remaining life analysis on each home sustem, but that ain't gonna happen
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Re: Go full in or pay off mortgage?

Post by moda0306 » Tue Jun 16, 2015 2:08 pm

Dragoncar,

I use 1% when I'm trying to make my arguments, because I don't want to appear to be cooking the books.  But I firmly believe 2% is more prudent, especially considering some cosmetic items start to look bad well-before they actually go bad.

Obviously more goes into this, and it's super important to do a mini-inventory of things that will NEED replacement early in a home's life if you're going to plop 20% down on one when you're 25 and barely have money to your name, anyway.  And obviously a lot of this has to do with the quality of the home purchased, but for me you weed that factor out by getting excellent, thorough inspections done before you buy, and have a realtor with an eye for quality construction, not just fancy appliances and a big bathroom.
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Re: Go full in or pay off mortgage?

Post by MachineGhost » Tue Jun 16, 2015 2:53 pm

moda0306 wrote: (once you account for house size, homes have actually lagged inflation)
Got a reference/link?
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Re: Go full in or pay off mortgage?

Post by moda0306 » Tue Jun 16, 2015 3:01 pm

http://michaelbluejay.com/house/appreciation.html
First, let's account for the fact that the average new home size exploded from 983 s.f. to 2349 s.f. from 1950-2004, or about 1.6% per year on average. (NPR)  So a big chunk of the increase isn't inflation, it's that bigger homes cost more money. O nce we factor that in, the price of new homes per square foot went up by only 4.2% annually from 1963 to 2008.

And now let's compare that rate to the general rate of inflation, which was 4.4% for the same period. (CPI, BLS)  As predicted earlier, the rate of real estate inflation and the general rate of inflation are almost identical.
On second look, the timeframes are staggered, but the home value period stopped in 2008, even though we were still coming down from a high for 3 more years after that point...

Here's a different timeframe:
The price of existing homes increased by 3.4% annually from 1987 to 2009, on average. (Wikipedia)  We don't adjust for houses getting bigger, because the Case-Schiller Index tracks repeat sales of the same homes. (They might get a little bigger from remodeling, but so few of them will get bigger, and by such a small amount, that we can safely ignore that.)  The general rate of inflation during this time was 2.9%. So again, the appreciation rate for homes was very similar to the general inflation rate.

It's really right around the inflation rate.  And it serves to remember that this is over a period where boomers were finding houses and/or upgrading to bigger ones.  That demographic bubble is leaving the job market and home-upgrading pool now.  The demographic affect on housing could be significant.

But I understand if you want to question a guy that looks like that guy does!! :/
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Re: Go full in or pay off mortgage?

Post by MachineGhost » Tue Jun 16, 2015 4:13 pm

moda0306 wrote: But I understand if you want to question a guy that looks like that guy does!! :/
You silly Millennials!  We all looked like that 25+ years ago. ;)  Well, except for the jocks and squares.
Last edited by MachineGhost on Tue Jun 16, 2015 4:30 pm, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by sophie » Tue Jun 16, 2015 5:49 pm

Tyler wrote: For sure.  No random rule of thumb on a message board should substitute for making well-informed decisions with your own money!  It's just a starting point for discussion.  Every situation is different. 

For the record, our first house was probably around 4x our net worth when we bought it.  I was laid off, sold the house, and moved for a great new job just before the housing crash.  Close call.

Our current house was just over 20% of our net worth when we bought it.  I was really tempted to pay cash, but I got a mortgage to keep options open and buy some time to sort out the early retirement plan.  By the time we paid it off a few years later it was less than that.  I really don't miss it.
That is a meteoric rise in your financial fortunes.  Excellent work!!

My first apartment was about 2.5x my net worth, and the expense really dragged down the financial ledger for the first couple of years.  I definitely don't recommend it.

Next one will be somewhere in the 50-65% of net worth range.  Much more comfortable.  I was wondering whether to stretch and go with cash/HELOC rather than a mortgage, but I think you all have saved me from that folly.

Incidentally I did consider renting for a while instead of buying again.  No way.  Rentals feel like...rentals, unless they're in shiny new investment buildings that charge a fortune.
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Re: Go full in or pay off mortgage?

Post by Matthew19 » Wed Jun 17, 2015 9:36 am

No one has mentioned that after you pay off your house you can always take out a mortgage again if you suddenly needed the money.

Mortgage origination fees are a little less than 1 year of interest so if you make it longer than that you'll come out ahead ceteris paribus right?
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Re: Go full in or pay off mortgage?

Post by moda0306 » Wed Jun 17, 2015 10:07 am

Matthew19 wrote: No one has mentioned that after you pay off your house you can always take out a mortgage again if you suddenly needed the money.

Mortgage origination fees are a little less than 1 year of interest so if you make it longer than that you'll come out ahead ceteris paribus right?
This is subject to underwriting.  If there are tight credit markets, or you have a financial emergency ensuing, this underwriting could make it far-more difficult for you to get a loan.

Home equity access is one of those things that's at its most inaccessible when you need it most.  I don't like building fragile contingencies like that into my plan.  It's like using a musket as your home defense gun. :)
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Re: Go full in or pay off mortgage?

Post by pugchief » Wed Jun 17, 2015 10:18 am

moda0306 wrote:
Matthew19 wrote: No one has mentioned that after you pay off your house you can always take out a mortgage again if you suddenly needed the money.

Mortgage origination fees are a little less than 1 year of interest so if you make it longer than that you'll come out ahead ceteris paribus right?
This is subject to underwriting.  If there are tight credit markets, or you have a financial emergency ensuing, this underwriting could make it far-more difficult for you to get a loan.

Home equity access is one of those things that's at its most inaccessible when you need it most.  I don't like building fragile contingencies like that into my plan.  It's like using a musket as your home defense gun. :)
You will also not get as favorable a rate on a 'cash out' mortgage compared to a purchase or refi.
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Re: Go full in or pay off mortgage?

Post by pugchief » Wed Jun 17, 2015 10:21 am

moda0306 wrote: http://michaelbluejay.com/house/appreciation.html
First, let's account for the fact that the average new home size exploded from 983 s.f. to 2349 s.f. from 1950-2004, or about 1.6% per year on average. (NPR)  So a big chunk of the increase isn't inflation, it's that bigger homes cost more money. O nce we factor that in, the price of new homes per square foot went up by only 4.2% annually from 1963 to 2008.

And now let's compare that rate to the general rate of inflation, which was 4.4% for the same period. (CPI, BLS)  As predicted earlier, the rate of real estate inflation and the general rate of inflation are almost identical.
On second look, the timeframes are staggered, but the home value period stopped in 2008, even though we were still coming down from a high for 3 more years after that point...

Here's a different timeframe:
The price of existing homes increased by 3.4% annually from 1987 to 2009, on average. (Wikipedia)  We don't adjust for houses getting bigger, because the Case-Schiller Index tracks repeat sales of the same homes. (They might get a little bigger from remodeling, but so few of them will get bigger, and by such a small amount, that we can safely ignore that.)  The general rate of inflation during this time was 2.9%. So again, the appreciation rate for homes was very similar to the general inflation rate.

It's really right around the inflation rate.  And it serves to remember that this is over a period where boomers were finding houses and/or upgrading to bigger ones.  That demographic bubble is leaving the job market and home-upgrading pool now.  The demographic affect on housing could be significant.

But I understand if you want to question a guy that looks like that guy does!! :/
Anecdotal, but I bought my current house in a stable midwestern market 24 years ago [moved from ~1800 sqft to ~2600] for around $300k. A similar model down the street just sold for over $500k.
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Re: Go full in or pay off mortgage?

Post by Libertarian666 » Wed Jun 17, 2015 10:50 am

pugchief wrote:
moda0306 wrote:
Matthew19 wrote: No one has mentioned that after you pay off your house you can always take out a mortgage again if you suddenly needed the money.

Mortgage origination fees are a little less than 1 year of interest so if you make it longer than that you'll come out ahead ceteris paribus right?
This is subject to underwriting.  If there are tight credit markets, or you have a financial emergency ensuing, this underwriting could make it far-more difficult for you to get a loan.

Home equity access is one of those things that's at its most inaccessible when you need it most.  I don't like building fragile contingencies like that into my plan.  It's like using a musket as your home defense gun. :)
You will also not get as favorable a rate on a 'cash out' mortgage compared to a purchase or refi.
Not necessarily true. I did a cash-out refinance a couple of years ago and got the same rate as a purchase or non-cash-out, namely 2.625% for 15 years. And taking the cash out also made my mortgage non-recourse! :-)
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Re: Go full in or pay off mortgage?

Post by moda0306 » Wed Jun 17, 2015 10:57 am

pugchief wrote:
moda0306 wrote: http://michaelbluejay.com/house/appreciation.html
First, let's account for the fact that the average new home size exploded from 983 s.f. to 2349 s.f. from 1950-2004, or about 1.6% per year on average. (NPR)  So a big chunk of the increase isn't inflation, it's that bigger homes cost more money. O nce we factor that in, the price of new homes per square foot went up by only 4.2% annually from 1963 to 2008.

And now let's compare that rate to the general rate of inflation, which was 4.4% for the same period. (CPI, BLS)  As predicted earlier, the rate of real estate inflation and the general rate of inflation are almost identical.
On second look, the timeframes are staggered, but the home value period stopped in 2008, even though we were still coming down from a high for 3 more years after that point...

Here's a different timeframe:
The price of existing homes increased by 3.4% annually from 1987 to 2009, on average. (Wikipedia)  We don't adjust for houses getting bigger, because the Case-Schiller Index tracks repeat sales of the same homes. (They might get a little bigger from remodeling, but so few of them will get bigger, and by such a small amount, that we can safely ignore that.)  The general rate of inflation during this time was 2.9%. So again, the appreciation rate for homes was very similar to the general inflation rate.

It's really right around the inflation rate.  And it serves to remember that this is over a period where boomers were finding houses and/or upgrading to bigger ones.  That demographic bubble is leaving the job market and home-upgrading pool now.  The demographic affect on housing could be significant.

But I understand if you want to question a guy that looks like that guy does!! :/
Anecdotal, but I bought my current house in a stable midwestern market 24 years ago [moved from ~1800 sqft to ~2600] for around $300k. A similar model down the street just sold for over $500k.
That's 2.15% per my financial calculator.  My guess is that is slightly lagging inflation.

That doesn't help us analyze debt pay-down too well, but it does help us get an idea of whether DEBT is the ultimate problem plaguing the world of home-ownership vs just having a big lazy asset on your balance sheet that produces more expenses than return on investment.

I probably seem like I'm lecturing home-owners here or something.  That's really not what I intend.  I think all assets should count as a balance-sheet item.  I think there are some really good benefits to home-ownership. I just have seen enough rationalization of decisions by both myself and others that I'm done accepting bad or incomplete arguments when we should be pointing out that the emperor has no clothes.  There is no reason that someone should feel bad for buying a house and rocketing down the debt.  I just don't like how it is USUALLY rationalized.
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Re: Go full in or pay off mortgage?

Post by Libertarian666 » Wed Jun 17, 2015 11:04 am

moda0306 wrote:
pugchief wrote:
moda0306 wrote: http://michaelbluejay.com/house/appreciation.html
On second look, the timeframes are staggered, but the home value period stopped in 2008, even though we were still coming down from a high for 3 more years after that point...

Here's a different timeframe:

It's really right around the inflation rate.  And it serves to remember that this is over a period where boomers were finding houses and/or upgrading to bigger ones.  That demographic bubble is leaving the job market and home-upgrading pool now.  The demographic affect on housing could be significant.

But I understand if you want to question a guy that looks like that guy does!! :/
Anecdotal, but I bought my current house in a stable midwestern market 24 years ago [moved from ~1800 sqft to ~2600] for around $300k. A similar model down the street just sold for over $500k.
That's 2.15% per my financial calculator.  My guess is that is slightly lagging inflation.

That doesn't help us analyze debt pay-down too well, but it does help us get an idea of whether DEBT is the ultimate problem plaguing the world of home-ownership vs just having a big lazy asset on your balance sheet that produces more expenses than return on investment.

I probably seem like I'm lecturing home-owners here or something.  That's really not what I intend.  I think all assets should count as a balance-sheet item.  I think there are some really good benefits to home-ownership. I just have seen enough rationalization of decisions by both myself and others that I'm done accepting bad or incomplete arguments when we should be pointing out that the emperor has no clothes.  There is no reason that someone should feel bad for buying a house and rocketing down the debt.  I just don't like how it is USUALLY rationalized.
Personally I ignore my house in terms of the balance sheet. Since my mortgage is non-recourse, that is reasonable as a matter of accounting. It is also conservative in that I don't count the "home equity" as part of my net worth.
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Re: Go full in or pay off mortgage?

Post by sophie » Wed Jun 17, 2015 1:58 pm

I agree with moda - a lot of people are advocating keeping little or no emergency funds, instead dumping it into the mortgage or other debt and opening a HELOC for emergencies.  I don't know how many people are doing that but that's just plain scary.  HELOCs are not forever or guaranteed, and if you've lost your job it's very, very hard to refinance.

Apart from a "safe" level of liquid savings - the amount of which is going to vary tremendously depending on individual circumstances - I'm completely in the pay it off camp.  To me, investing money while holding mortgage debt might work in your favor mathematically, but it's uncomfortably similar to investing on margin.  I just can't bring myself to do it, and you might also recall HB's Rule #7:  "Don't use leverage."

I'm rather influenced by my parents on this one:  they never once applied for a mortgage.  When they bought their first house, they arranged to take over the existing mortgage.  For their second house, they borrowed the money from family and paid it off before any of us got close to college age (about 10 years).  The resulting financial flexibility was invaluable - for one thing, they were able to pay for four college educations spaced 2 years apart, on one rather modest income.  Certainly rates were higher then so it made more sense, but savings interest rates were higher then too.
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Re: Go full in or pay off mortgage?

Post by Libertarian666 » Wed Jun 17, 2015 2:18 pm

sophie wrote: I agree with moda - a lot of people are advocating keeping little or no emergency funds, instead dumping it into the mortgage or other debt and opening a HELOC for emergencies.  I don't know how many people are doing that but that's just plain scary.  HELOCs are not forever or guaranteed, and if you've lost your job it's very, very hard to refinance.

Apart from a "safe" level of liquid savings - the amount of which is going to vary tremendously depending on individual circumstances - I'm completely in the pay it off camp.  To me, investing money while holding mortgage debt might work in your favor mathematically, but it's uncomfortably similar to investing on margin.  I just can't bring myself to do it, and you might also recall HB's Rule #7:  "Don't use leverage."

I'm rather influenced by my parents on this one:  they never once applied for a mortgage.  When they bought their first house, they arranged to take over the existing mortgage.  For their second house, they borrowed the money from family and paid it off before any of us got close to college age (about 10 years).  The resulting financial flexibility was invaluable - for one thing, they were able to pay for four college educations spaced 2 years apart, on one rather modest income.  Certainly rates were higher then so it made more sense, but savings interest rates were higher then too.
Your parents actually had mortgages on their first two houses, regardless of whether they applied for them or called them by that name.

So I'm not following how they influenced you not to have a mortgage.  :P

And as for why HB said not to use leverage, that was because it allows you to lose more money than you put up. However, if you have a non-recourse mortgage, that doesn't apply.
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Re: Go full in or pay off mortgage?

Post by LC475 » Wed Jun 17, 2015 2:25 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.
Ahh, but what is high?  I would say: the price of the house is high.
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Re: Go full in or pay off mortgage?

Post by moda0306 » Wed Jun 17, 2015 2:33 pm

It seems a bit odd to me to only apply the "don't use leverage" rule once you've just used leverage... especially if, as it so often is, to purchase something that is an almost guaranteed financial loser compared to "rent and invest the difference," if you will, within a small place.

Essentially, any time you use debt you're doing SOMETHING on margin... whether investing or funding lifestyle.  A home is usually a bit of both, in a way (it is an asset on your balance sheet that comes at a net cost, on an opportunity-cost/risk-adjusted basis. 


But when you "don't pay down debt" and build up, say, a safe bond portfolio instead.  You maybe could call that "investing on margin."  However, which is worse, borrow @ 3.5% and invest @ 3% in a liquid asset, or borrow @ 3.5% to buy an illiquid asset with 3% CC's on the front end, 6.5% realtor fees on the back end if you want to take the months it would to rid yourself of it, and while it's value will go up with inflation, you'll also incurring taxes, maintenance, utilities, and insurance that you wouldn't come close to incurring in a small rental?

The investing on margin of the worse sort, in my mind, comes when you buy too much house, or house you don't need.  That's the one that deserves most of our focus, if we're going to focus anywhere.  That's where people end up costing themselves the most amount of pain... Rationalizing the purchase, and using debt to help bad math go worse.

But maybe that's not so bad... If someone can go into massive debt to buy a house they don't need, how bad is it, really, to go into debt in your 20's to travel?  Or for a fun car?  To me, if you're going to use debt to finance lifestyle, you are taking risk, but embrace it if you're going to do it, and get the most out of it... but most importantly admit it is happening.


Long-story short, if we really, really shouldn't invest on margin, unless you can pay off your house right now (or have it paid off), you should sell it and move out and clear the mortgage, because you're investing AND consuming on margin when you buy a home you don't need with a mortgage.
Last edited by moda0306 on Wed Jun 17, 2015 2:45 pm, edited 1 time in total.
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Re: Go full in or pay off mortgage?

Post by Tyler » Wed Jun 17, 2015 3:29 pm

sophie wrote: To me, investing money while holding mortgage debt might work in your favor mathematically, but it's uncomfortably similar to investing on margin.  I just can't bring myself to do it, and you might also recall HB's Rule #7:  "Don't use leverage."
+1.  BTW, it works in your favor in real life way less often than most people realize.  Average returns mask a lot of volatility that fixed mortgage payments don't care about.

http://oi61.tinypic.com/2zsuq1s.jpg

Pay close attention to the net profit vs mortgage rate distribution -- The results are pretty counter-intuitive.  Lower rates do not guarantee higher profit!  Rates are not set in an economic vacuum.  Even when they are very low relative to the historic average, markets are not guaranteed to perform at the historic average.  If you truly hold your mortgage for 30 years at today's rates you're most likely in very good shape, but most people come nowhere near that in the same home (see behavior benchmarks).

You can see the leverage aspect of a mortgage in the fact that net profits can go negative.  That's when the comparable investment loss including fixed mortgage payments exceeds the principal remaining on the loan.  Because most people just lump all their investments together and don't really think of their mortgage leverage separately, many may hit that mark during bad markets without even realizing it.

FWIW, the PP looks a lot more like you'd expect.

http://oi58.tinypic.com/209gdg4.jpg

Median net profit is lower, but because the volatility is lower and performance is independent of economic conditions, you generally get more net profit with lower mortgage rates.  At today's rates, that's most likely a good deal. 
Last edited by Tyler on Wed Jun 17, 2015 4:35 pm, edited 1 time in total.
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