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Yes, most people are just unwilling to compromise and have to buy something detached on the perfect street, with a view, fully upgraded, etc....which can't really be found for under 400k
...with a garage, spacious, with no freeway noise, walkable, not near apartments and so on.
I agree with the overall sentiment of live below your means. If one is disciplined enough like you've been, I think it's wiser to take out a standard 30/fixed mortgage and invest the monthly payment difference in a simple stock/bond mix. With nominal 30-year rates around 4%, that works out to an expected real rate of 2% or less. This is much less than even a conservative portfolio allocation. It is also a great hedge against higher inflation.
If you're really set on mortgage prepayment concept, get a 30/fixed but make the same monthly payment as if it were a 15/fixed. The difference in timing and interest costs is pretty minimal (so long as the rate spread is the typical 1% or less) but having the 30-year gives you cash flow flexibility in case of job loss, illness, et cetera.
These are definitely things to consider, and I appreciate your bringing this stuff up. We chose to go with the 15-year mortgage to get the lower interest rate in addition to the lower term. I like the idea of more cash flow flexibility with a 30, but with a 15 the difference in monthly payment was only a few hundred dollars for us. Plus there are so many other things each month that tend to compete for that additional principal payment. We're pretty disciplined, so I'm sure we could manage it better than many other folks.
I also didn't emphasize it above, but we have been saving and investing the whole time too. Our home/mortgage strategy was established after our investing strategy was being executed. We have not been paying down the mortgage instead of investing, but rather have been using discretionary money to pay down the mortgage. Once the mortgage is paid off in a few more years, we'll kick our investing up even further. Although we could've invested the difference between a 15 and a 30 each month, and maybe even be mathematically ahead at this point, we view paying off the mortgage early as one key way to manage risk. A job loss/change or move to a new city is generally much easier if there is no mortgage involved.
These are definitely things to consider, and I appreciate your bringing this stuff up. We chose to go with the 15-year mortgage to get the lower interest rate in addition to the lower term. I like the idea of more cash flow flexibility with a 30, but with a 15 the difference in monthly payment was only a few hundred dollars for us. Plus there are so many other things each month that tend to compete for that additional principal payment. We're pretty disciplined, so I'm sure we could manage it better than many other folks.
I also didn't emphasize it above, but we have been saving and investing the whole time too. Our home/mortgage strategy was established after our investing strategy was being executed. We have not been paying down the mortgage instead of investing, but rather have been using discretionary money to pay down the mortgage. Once the mortgage is paid off in a few more years, we'll kick our investing up even further. Although we could've invested the difference between a 15 and a 30 each month, and maybe even be mathematically ahead at this point, we view paying off the mortgage early as one key way to manage risk. A job loss/change or move to a new city is generally much easier if there is no mortgage involved.
I agree that if one is conservative in home much home to buy, the cash flow difference between a 15 and 30 year is a minimal percent of the budget.
A disagree that paying off a mortgage early reduces risk (again assuming one is disciplined in saving surplus versus blowing it). Assumptions:
A 15-year's PI payment is around 54% more per month. The PI30 is 1083/mo while PI15 is 1672/mo or $589/mo more. Assume 15 years ago we both bought the same exact house for the same amount except you took a 15/fixed at today's rates and I took a 30/fixed at today's rates. I took my "extra" $589/mo and invested it in a fairly low risk allocation yielding a nominal 7%.
Today we both lose our jobs. You don't have a mortgage payment but I still do (I owe around $156K), so I need an extra $1083/mo more than you do. However, that extra that I invested each month is now worth $190K. I could take my $190K and pay off my mortgage plus have an extra $34K cash. Of course in that situation that would be silly. Instead, that $190K will cover the extra $1083/mo I need for 175 months or over 14 years.
The same general concept applies if today we both get transferred out of state.
The only way the 30-year doesn't make sense using today's rates is if we had a period of extended and unprecedented deflation or if there is an extended and unprecedented (ie never happened before) period of returns in the market (the worst 20-year rolling average return was around 2.5% which still beats today's likely mortgage spread). Keep in mind, too, that a paid off house still requires real estate taxes and insurance, plus maintenance. Failing to pay real estate taxes will likely result in losing your home just as failing to pay mortgage payments will.
A 15-year's PI payment is around 54% more per month. The PI30 is 1083/mo while PI15 is 1672/mo or $589/mo more. Assume 15 years ago we both bought the same exact house for the same amount except you took a 15/fixed at today's rates and I took a 30/fixed at today's rates. I took my "extra" $589/mo and invested it in a fairly low risk allocation yielding a nominal 7%.
Today we both lose our jobs. You don't have a mortgage payment but I still do (I owe around $156K), so I need an extra $1083/mo more than you do. However, that extra that I invested each month is now worth $190K. I could take my $190K and pay off my mortgage plus have an extra $34K cash. Of course in that situation that would be silly. Instead, that $190K will cover the extra $1083/mo I need for 175 months or over 14 years.
The same general concept applies if today we both get transferred out of state.
The only way the 30-year doesn't make sense using today's rates is if we had a period of extended and unprecedented deflation or if there is an extended and unprecedented (ie never happened before) period of returns in the market (the worst 20-year rolling average return was around 2.5% which still beats today's likely mortgage spread). Keep in mind, too, that a paid off house still requires real estate taxes and insurance, plus maintenance. Failing to pay real estate taxes will likely result in losing your home just as failing to pay mortgage payments will.
Thanks for the analysis. Don't forget to account for the taxes and 10% penalty due if breaking into that IRA/401(k) before age 59.5. Hopefully there's a cash emergency fund in place to float 3-6 months of expenses during a job transition so no need to break into retirement savings.
With the example above, assuming average 7% rate of return, if you'd invest $589 per month for 30 years you'd have ~$714k at the end of 30 years and I'd invest $1672 per month starting with year 15, and have ~539k at the end of 30 years. We'd both have a paid-off mortgage, but you'd come out ahead with investments.
However, my actual approach would also involve mortgage principal pre-payments. With my 15-year plus some additional pre-payments, my actual mortgage payoff goal would be more like ~10 years, then I'd take that entire P&I payment amount and add it to my investing for the next ~20+ years. In this scenario, you'd still invest $589 per month for 30 years, but I'd now invest $1,672 per month for 20 years starting in year 10. Assuming 7% as we did above, at the end of 30 years, you'd still have ~$714k but I'd now have ~$880k. Of course if you also add pre-payments into the mix the analysis gets more complicated.
There's not necessarily a right or wrong answer here. Both approaches have some validity depending on one's situation, goals, income/expenses/savings, risk profile, etc.. Both of us would have a paid-off house as well as a nice nest egg. Plus, this would be on top of any other investing we have been doing in parallel. With all of this said, I'd likely modify my mortgage approach if I actually had zero retirement savings at the start of our example.
I do wish I was making all of this happen in CA rather than in WI. I wouldn't prefer to start another mortgage in CA after my current WI one is paid off, but depending on the timing/location of everything I may not need to do so. But I'm willing to take a step back to take two steps forward to live in my favorite place, and it will be much easier to do so in my current season of life than if I was just starting out. I'm glad I started investing in good growth stock mutual funds and real estate early in life.
Thanks for the analysis. Don't forget to account for the taxes and 10% penalty due if breaking into that IRA/401(k) before age 59.5. Hopefully there's a cash emergency fund in place to float 3-6 months of expenses during a job transition so no need to break into retirement savings.
I was thinking the investing would be done in a post-tax account, so the initial income taxes would be the same whether one was putting the money toward a mortgage or toward investments. Investments in a post-tax account might be tax advantaged (e.g. Roth IRA) or not. If not, I was assuming investments would be made into tax-efficient funds.
Quote:
Originally Posted by Ragnar
Also with my 15-year plus some additional pre-payments, my actual mortgage payoff would be more like ~10 years, then I'll take that entire P&I payment amount and add it to my investing for the next ~20+ years. In the example above, you'll invest $589 per month for 30 years, but I'll invest $1,672 per month for 20 years starting in year 10. Assuming 7% as you did above, at the end of 30 years, you'll have ~$714k and I'll have ~$880k. This is on top of any other investing we have currently been doing. With all of this said, I would likely modify my mortgage approach if I had zero retirement savings at the start of our example. There's not necessarily a right or wrong answer here. Both approaches have some validity depending on one's situation, goals, income/expenses/savings, risk profile, etc..
In your new example above, you've got to up my $589/mo investment for the first 10 years by whatever amount you're prepaying extra principal. From an objective mathematical standpoint, you will never come out ahead of me in these scenarios if I can get a return on my investment of more than the real mortgage rate. At today's historically low mortgage rates, the current real rate is around 2% (it's actually a little less than this for many people due to the deductibility of mortgage interest). The worst 20-year period in stock market history yielded 2.5%. Think about it from a slightly different angle. Paying or prepaying a mortgage is essentially getting a return of the real mortgage rate (2% recently). If one can get a rate of return higher than that 2% in other investments, then mathematically speaking one should do everything possible to minimize cash going toward a mortgage and instead invest the rest. That is, put down the lowest amount possible, take out the longer term, and never prepay. Again, that requires the discipline to invest the rest instead of spend it on something else.
All this of course does not account for subjective emotional factors such as peace of mind.
Quote:
Originally Posted by Ragnar
I do wish I was making all of this happen in CA rather than in WI. I don't prefer to start another mortgage in CA after my current WI one is paid off, but depending on the timing of things I may not need to do so. But I'm willing to take a step back to take two steps forward to live in my favorite place, and it will be much easier to do so in my current stage of life than if I was just starting out. I'm glad I started investing in good growth stock mutual funds and real estate early in life.
This we agree on 100%. California is a better place once you are already established and well off financially. Many areas are better places to get established and well off. I just posted in another thread that my current home base area has nearly 2x the median income of SD county while median SFH prices are about 1/3 of the median SD county SFH prices. And state income tax is much less. These three factors combined make a tremendous difference, especially compounded over time.
Not necessarily. It really depends on how the household manages income and expenses. Just because you have a great income doesn't mean you need a bigger home right away in those cheaper areas of the country. For example my wife and I lived for a few years in a small, older $160k home in WI for 8 years after we were first married. We started with a 30-year, but saved and refinanced to a 15-year mortgage, with super manageable monthly payment. We could've easily been able to live in something nicer with a higher mortgage and property tax payment, but we were able to save a lot, and as a result rolled over $100k cash/equity into a newly-built custom home a few years ago.
Point taken. However, you had income from your home appreciation as well as from your job. That is how most people get a sizable down payment.
Point taken. However, you had income from your home appreciation as well as from your job. That is how most people get a sizable down payment.
Everyone that bought before 2000 should have about 3-4 hundred thousand in equity unless they went crazy doing upgrades.
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