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Agree with most of what’s already been said – if you have a low interest rate relative to the returns on your portfolio, then carrying a mortgage and not trying to pay it off quickly makes sense.
With the market tumbling, and interest rates climbing, I’m feeling pangs of regret in not taking out a home equity loan back in November or December 2021. We retired a couple weeks ago and now have to rely on our portfolio for income at a time when withdrawing from it will be painful. Fortunately we have a cash buffer for a year or two.
Otoh, with inflation raging and our home value reaching dizzying pandemic heights, I’m feeling pretty good about a 2% fixed mortgage. It’s really the only offset to the rest of our net worth portfolio, which has definitely taken a hit.
I’m starting to understand why wealthy people carry a lot of debt. It’s because they can; and it lets them keep their invested money invested where it will work harder for them than paying the interest on loans (at least loans that were taken out up until lately).
Thanks to the rise in bond market yields, we’re reaching a tipping point today — mid-May 2022 — where some mortgage borrowers may find they can earn more by buying bonds than paying down their home loans. For four decades, that typically hasn’t been the case. But the math has now changed, at least for some homeowners.
Years ago, I noticed beer cans on my lawn.
Some tossed among my neighbor’s lawns also.
I picked them up and throw them into my return empty bin.
After weeks of finding them, I was getting aggravated.
I returned my bottles & cans and the beer cans for the deposit.
My next errand was my bank…… Idea!!!
Use the empty’s to prepay my mortgage at my bank.
Beer can equity !
For months, I payed down my principal with beer can donations.
Sorry to say, the lawn donations stopped.
But, I continued to prepay with empty’s till the mortgage was paid.
I want to Thank that guy some day.
Paying off a mortgage should only be considered if all 401(k) and IRA contributions have been maxed out. You also need to ensure that you are not carrying any higher cost debt. Once those boxes are ticked, it really comes down to your risk-orientation. If you are a risk accepter and your after tax mortgage cost is low (say below 2.5%), the best move in my mind is to keep the low-cost debt and invest for the long-term.
If you have a long time horizon, the financially optimal answer is usually ‘no’. However, for financial risk reduction the optimal answer is generally yes. Lastly, the emotionally optimal answer is often ‘yes’.
Which you go with is a personal choice.
For those on the cusp of retirement, it seems like a good idea if you have plenty of near-cash reserves to tide you over in event of a market crash. The stock market is sky high. It might be good to harvest some of the gains and decrease required monthly cash outlay.
I am about to retire with decent savings, but without a meaningful pension. I am only 60, and don’t plan to collect SS until 70. As I get ready to switch from saving to spending, the importance of income and cashflow is coming into sharp focus.
I haven’t paid the mortgage off yet because I am unsure of which type of account to take it from – retirement or non-retirement, if retirement Roth or 401K? I am trying to catch up on my financial literacy and figure it out before the market crashes.
Thanks Jonathan for this site – its an awesome resource!
I paid cash for a house 24 years ago. I have HELOC now, which allows me to use up to 80% of the equity. I’ve only done that twice in the past few years. The last time was in April 2020. Put the entire amount into 4 stocks. 3x my money. Then pay back the HELOC loan. The risk/reward when I saw the prices of a few stocks I liked seemed very good.
Often times it comes down to the interest rate. I paid cash for my first home when interest rates were moderate to high. I sold that house this past March and bought another house. I could have paid it off, still can anytime I want, but at a 2.35% mortgage rate via a VA loan that doesn’t make sense to me. The General consensus is that interest rates will soon go up across the board along with inflation but that 2.35% interest rate is fixed and can never change. If my rate was 4-5% I would think much differently, but at 2.35% it is a no brainer whether I itemize or not. So the one answer solution doesn’t apply. It all depends.
I have found that being debt free provides me with a wonderful sense of well-being. I wouldn’t trade it for a larger portfolio.
Paying off a mortgage creates another floor under your personal net worth and creates cash flow that can then be invested in other areas that might add risk. The way I see it, buying stocks without paying off a mortgage is no different than investing on margin.
Another consideration is taxes. If you are not itemizing, then paying off a mortgage is like a tax free bond return, while other investments often add to taxable income. In other words, a 3% mortgage is closer to 4% after taxes. That’s a pretty good return in this environment.
Finally, it helps me sleep at night. That’s the best return on investment.
I agree completely, Gene.
In my mind, it’s fine to balance investing and mortgage prepayments, realizing that the mortgage’s interest rate is a cost of funds to the investing, so the mortgage rate should be deducted from the antcipated gross investment return to get to the real anticipated return.
Given this cost of funds reality, and the tax treatment of the mortgage prepayments that you rightly note, it’s a no-brainer to me to prepay the mortgage before investing in bonds (particularly since the mortgage prepayment is, literally, a risk-free investment).
Plus, mortgage prepayments come with a “reverse annuity payment” — one that accrues to the homeowner, when the mortgage is paid off and the the monthly house payment stays in one’s wallet.
Finally, once the mortgage is paid off, future investment is made with lower risk, since the mortgage “cost of funds” is eliminated.
The difference is that a margin loan is variable and you can get a fixed mortgage in the 2% range. Margin rates could easily go up to 10% + in the near future as inflation skyrockets and interest rates do the same. So I hear you. At todays fixed interest rates it will likely almost be considered a free loan in the next 5 years or so. Those who have variable home loans are the ones who should jump ship while they can.
I’ve been thinking about that too, and agree that paying mortgage rates is like paying a bond. Then realized that if I take money out of my IRA I’d pay taxes on the distribution, and possibly push myself into a higher tax bracket. So the reasoning above works–but only if you have a taxable account without too much in capital gains.
Maybe. If you’re working, love where you live, saved at least six months of take-home pay for unexpected needs, and have retirement savings on track, then yes, pay down your mortgage faster. I’d do it again, even if bond yields were higher, for the greater happiness and better cash flow.
“Greater happiness” doesn’t strike me as a reason that can be generalized. Whether you want more or less leverage is a function of your tolerance for risk.
Not all of us are wired the same, if you sleep better at night or have less stress with a paid off home, that seems like a greater happiness to that person or people.
My happiness here has more to do with satisfaction from reaching a long-term goal and the freedom of outright ownership, than it does any connection to risk in the assets we own.
I paid off my first home’s 30-year mortgage in 13 years. Yes, I would have earned more by putting the money in stocks. But in my mind, that wasn’t the alternative. Instead, I viewed paying down my mortgage as a substitute for buying bonds—one that offered a higher return.
Yes, if you have bonds in your portfolio yielding less than the after-tax cost of your mortgage, it makes sense to pay off your mortgage first. But if you want leverage to increase your exposure to equities, a mortgage is the cheapest way to borrow for retail folks, i.e., those of us who aren’t corporations and able to issue bonds.
I agree. But how many people are 100% in stocks or close to it? In my experience, even the folks who say they’re fully invested in stocks (a boast you only hear after the market has had a good run) turn out to have at least some money in bonds, where it’s earning less than their mortgage rate.
I really think it’s fine to own bonds and have a mortgage. It’s tough not to do both at some point in your life. I think paying a mortgage off early is fine too. It’s all in what you value.
I was roughly 100% stocks for my first decade of investing. After two crashes, and getting older, I went to 60/40, but realized that was too conservative for me, so I’ve been about 75/25 since.
I am in no hurry to pay off my mortgage, at 2.5% vs my long term portfolio return of about 8.5%… I really enjoy the arbitrage. There are a lot of ‘correct’ answers.
Outside of owning a house. 95% stocks, 5% cash . Never any bonds. Worked fine for me for the past 30 years.