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Nothing to do with Dave Ramsey. It's common sense. Nobody in their right mind would take out a mortgage on their house in order to invest money, so why on earth would you engage in serious investing before you paid off your mortgage?
The opportunity cost is the reason I tend to hesitate when people talk about paying off their mortgage early. I'd caution you about two things. First, when would you like to retire? If you plan to retire early, investing it might be wise to two advantage of the benefit of time and compounding interest to amass a nice nest egg that can give you some additional options when you get older. The otherwise factor to consider is the tax implications of retiring your mortgage, especially since your interest rate is so low. Personally, I have a nice balance between investing taxes income and pay extra on my mortgage (weighted more heavily toward investing). Could I pay the house off faster? Yes, but I think diversification is an important principle to keep in mind. Remember, mo eg in a house is not liquid and is subject to boons and busts just like anything else.
This is a common misunderstanding of asset allocation when leverage is involved.
The amount you have invested in the house is the entire value of the house, not just the equity. If it goes up or down in value, you gain/lose the entire amount of gain or loss. The amount you owe the bank stays fixed, so the bank does NOT share some gain/loss simply because you owe money on the house. 100% of the gain/loss goes to YOU, the sole owner of the house.
Thus your exposure to the house does NOT increase when you pay down the mortgage. You were already fully invested (that is, had invested the entire amount) the day you closed on the purchase.
Don't worry about opportunity cost. Remember that paying down the mortgage is a bond-like investment and your retirement account is very healthy. Just get your retirement account more equity-heavy with the funds ALREADY in it (for example, move $1000 from bonds to stocks each month, or $12000 each year) and then use income to really attack the mortgage. You are thus not forgoing stocks by paying down the mortgage! With what you save on interest, there is no net opportunity cost with this strategy, because your bonds probably will earn less over the next 10 years than your mortgage costs you.)
Just keep something like 5-10% of your portfolio in bonds for rebalancing.
Who says you can't have peace of mind and decent investments also?
This is pretty awesome, I never thought of it this way before. I used to be in the "don't pay your mortgage off early" camp (because of the greater stock market returns), while also investing a part of my portfolio in bonds that aren't getting as good of a return as paying off the mortgage!
Just thought you'd like to know, you CAN change the minds of stubborn internet strangers, so thank you!
On a related note, how would interest deductions and house appreciation work into the equation? Say there's a $300k mortgage note for 30 years, 4.5% interest. What would be the effective return for contributing $100/mo to the mortgage vs $100 getting 4.5% for 30 years, including interest deductions and house appreciation?
This is pretty awesome, I never thought of it this way before. I used to be in the "don't pay your mortgage off early" camp (because of the greater stock market returns), while also investing a part of my portfolio in bonds that aren't getting as good of a return as paying off the mortgage!
Just thought you'd like to know, you CAN change the minds of stubborn internet strangers, so thank you!
On a related note, how would interest deductions and house appreciation work into the equation? Say there's a $300k mortgage note for 30 years, 4.5% interest. What would be the effective return for contributing $100/mo to the mortgage vs $100 getting 4.5% for 30 years, including interest deductions and house appreciation?
Yes, I have never thought of that too. I am adjusting my portfolio to accommodate this. Thanks!
The opportunity cost is the reason I tend to hesitate when people talk about paying off their mortgage early. I'd caution you about two things. First, when would you like to retire? If you plan to retire early, investing it might be wise to two advantage of the benefit of time and compounding interest to amass a nice nest egg that can give you some additional options when you get older. The otherwise factor to consider is the tax implications of retiring your mortgage, especially since your interest rate is so low. Personally, I have a nice balance between investing taxes income and pay extra on my mortgage (weighted more heavily toward investing). Could I pay the house off faster? Yes, but I think diversification is an important principle to keep in mind. Remember, mo eg in a house is not liquid and is subject to boons and busts just like anything else.
The only thing you may want to watch out for is that overtime your "allocation" to "fixed income" ie the mortgage reduces naturally overtime. So 4% interest rate on a 200k mortgage doesn't mantain the investment weighting although the 4% stays static
Dmills, I'm in my late 30's, mortgage still own ~$350k (house worth ~$700k), no other debt, retirement saving over $800k, emergency fund at 5% net worth, 2 kids at young age. The reason I consider paying off early b/c in case I get layoff, I'll still be debt free and no need to stress to find the next job. My investment philosophy is: live within the means, save as much as possible, "don't buy stuff we don't need with money we don't have.", I max my 401 and Roth every year. If I pay extra in mortgage, I think I can pay it off in 16 more years. My thinking is: being debt free is pretty cool, 'cos I can spend time on more meaningful things in life instead of worrying about paying for house every month. The potential downside is, I may lose out on retirement return and compound interest over time etc.
You're in an excellent position that most people would agree.
I think what "some" may be missing is the opportunity cost by buying some excellent companies at bargain prices when the "opportunity arises". Having paid off all that 3.5% mortgage debt by $100-$200k you may miss the chance to snag a boatload of shares of a solid company like Wells Fargo at $14 in 2009, now at $55. I didn't, (although I am not not a fan of theirs). have some funds available to pick up disruptors and leaders like Apple, NetFlix, etc.. Sure payoff some debt but leave a good chunk for inevitable market downturns. I bought Wells at that time as simply a bet on America would not collapse financially.
Speaking of which, we haven't had a market correction of 10% for over 7 years. We are long overdue and an opportunity will present itself for those who have cash. Putting $100k into a stock that goes up 100% in 3-6 years is a much better proposition.
Sure it is risky, then make it less risky with $50k on the sidelines for an opportunity and put 50k into the home. Or 40/60, 30/70, etc.
You're in an excellent position that most people would agree.
I think what "some" may be missing is the opportunity cost by buying some excellent companies at bargain prices when the "opportunity arises". Having paid off all that 3.5% mortgage debt by $100-$200k you may miss the chance to snag a boatload of shares of a solid company like Wells Fargo at $14 in 2009, now at $55. I didn't, (although I am not not a fan of theirs). Apple, NetFlix, etc.. Sure payoff some debt but leave a goodchunk for inevitable market downturns. I bought Wells at that time as simply a bet on America would not collapse financially.
Speaking of which, we haven't had a market correction of 10% for over 7 years. We are long overdue and an opportunity will present itself for those who have cash. Putting $100k into a stock that goes up 100% in 3-6 years is a much better proposition.
Sure it is risky, then make it less risky with $50k on the sidelines for an opportunity and put 50k into the home. Or 40/60, 30/70, etc.
The other side of the coin is that in the last 14 years or so the s&p has had average returns well under mortgage rates
This is pretty awesome, I never thought of it this way before. I used to be in the "don't pay your mortgage off early" camp (because of the greater stock market returns), while also investing a part of my portfolio in bonds that aren't getting as good of a return as paying off the mortgage!
Just thought you'd like to know, you CAN change the minds of stubborn internet strangers, so thank you!
Quote:
Originally Posted by numberfive
On a related note, how would interest deductions and house appreciation work into the equation? Say there's a $300k mortgage note for 30 years, 4.5% interest. What would be the effective return for contributing $100/mo to the mortgage vs $100 getting 4.5% for 30 years, including interest deductions and house appreciation?
Ok, well the appreciation of the house is the same regardless of how much is owed on it, so it really is not part of the equation here. Remember we are not discussing renting vs. owning, rather, we are discussing owning with more debt vs. owning with less debt. You get the full appreciation either way.
As far as tax deductions, your rate on marginal mortgage debt (which is relevant for the discussion of extra payments each month rather than a lump sum), is simply your rate * (1 - marginal tax rate), if your itemized deductions exceed the standard deduction. If they do not, and thus you take the standard deduction, you should ignore the deduction and the after-tax rate is equal to the before-tax rate.
For 25% tax bracket, the after-tax rate if itemized deductions exceed the standard deduction is, for a 4.5% loan, thus 4.5%(1-(25%/100%)) = 3.375%.
However, as the loan is paid down and the standard deduction amounts go up with inflation each year, you will get to a point where you get no tax break and thus the after-tax rate is the same as the before-tax rate, which in your example is 4.5%.
If the bonds in question are in a retirement account (Traditional 401k/403b/IRA or Roth), then the after-tax rate on the bonds is the same as the before-tax rate*. On the other hand, if the bonds are in a taxable account, then the after-tax rate is less. In the latter case, the tax on the interest roughly washes with the deduction for the mortgage, if the rates are close to each other.
*Assuming that your bracket in retirement is comparable to that while working. If it isn't, and the account is Traditional, it is more complicated.
everyone situation is different. I paid off mortgage on a 490k house and couldn't be happier. I am maxing out 401k and stash the cash on other investment forms. It depends on your financial obligations and income level as well.
If you're putting 20% to your mortgage payment every month, you're doing the right thing by saving interests. Don't think about peace of mind, think about investments as well...if you paid off a house, you can save up to buy another estate as an investment and further that path and you will be a millionaire in time. It takes a lot of hard savings and planning but you'll succeed if things are executed in a safe and proper way.
e...if you paid off a house, you can save up to buy another estate as an investment and further that path and you will be a millionaire in time.
Ok, I have to admit I don't get this idea. Paying off a 3.5% debt only to take on a new loan at a potentially higher rate to buy another property?
This just doesn't make sense. A better idea is to invest it conservatively and then buy the property when you have 50% or 75% down or whatever it takes to manage the payments. Then whichever property you are not living in can be rented for income.
Better to carry debt at a lower rate than at a higher one.
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