2nd change of subject/pace: Mortgages

Financial Independence/Retire Early -- Learn How!
Post Reply
peteyperson
**** Heavy Hitter
Posts: 525
Joined: Tue Nov 26, 2002 6:46 am

2nd change of subject/pace: Mortgages

Post by peteyperson »

I'd like to run some numbers by the smart people here and see whether I'm right in the way I look at this issue.

When calcuating the variable (possible) benefits of investing in an excelerated mortgage debt paydown vs. low-cost index fund investing, I consider different issues.

Comparisons

Stocks: At a historical 4.5% growth + 4.2% dividend payout, 8.7% average gross, I would normally subtract 0.5% for investment costs (lowest cost UK index fund) and 3% for inflation. Having removed the speculative element of the historical return, that delivers 5.2% growth pre-tax. Theoretically.

Mortgage: Rates are 4.5%. There are no costs to make extra payments (read: investment costs), no inflation issues, however we are on a variable rate mortgage system in the UK and we're at 48 year lows on rates. I expect over the next few years for the rates to go up at least a couple of points. Averaged over the next decade I would assume at least 5.5% average. 5.5% would put me over the top of what the market has delivered on average. It comes with no tax consequences (thought taxes can be avoided up on up to $10k over new investments annually). If rates don't go significantly lower, it represents a low risk guaranteed return. Stocks IMHO have just had an almost 2 decade unpresidented run, are overvalued and are unlikely to continue to the moon. I think stocks will make a poor investment over the 5-10 year near term.

Offset Mortgage, thanks to Richard Branson

We have the option of an offset mortgage here now. A savings account attached to the mortgage account. If you owe $100,000 but have $10,000 saved, the bank charges you interest on the balance outstanding, $90,000. You pay the same mortgage payment monthly, but you get the double benefit of a reduced balance remaining as well as more of your monthly payment being attributed to principle rather than interest. You also have the added flexibility of being able to withdraw some or all over the savings account cash at any time, which allows for re-allocating it should the market drop down to a bargain P/E of 10. You can also park your emergency cash there too and get an inflation-beating 4.5% net return while you do..

Inflation, straight up but with a twist!

My twist on inflation is that assuming the interest rates don't rise, when I get an inflation payrise, I can take the % of my net pay that goes to the mortgage, and pay that portion as an additional principle payment. So not only does investing in your mortgage have no inflation element that reduces your return, but you can turn that into something which earns more for you both in reduced balance & interest savings over the term. This benefit escalates annually as you get another payrise, you add that to your monthly overpayment. Painless. Setup a monthly automatic transfer for that amount and each year, update it to add the new pay bump. So the overpayments snowball up each year and you don't need big salary bumps to do it.

Concluding thoughts and questions

Are there other issues I haven't considered? Perhaps looking at alternative investments that may not be stocks but may deliver a better return? Is there a fault in my math or the direction of my thinking?

How many people here have paid off their mortgage? How soon into taking it out did you pay it off i.e. just before FIRE or 8 years into taking it out. Was it a strategy to get rid of it early?

Petey
therealchips
*** Veteran
Posts: 174
Joined: Sat Jan 04, 2003 4:00 am
Location: Henderson, Nevada, USA

Post by therealchips »

Petey said
Are there other issues I haven't considered? Perhaps looking at alternative investments that may not be stocks but may deliver a better return? Is there a fault in my math or the direction of my thinking?

How many people here have paid off their mortgage? How soon into taking it out did you pay it off i.e. just before FIRE or 8 years into taking it out. Was it a strategy to get rid of it early?

I bought my first house in 1974 with a thirty-year 9.5% mortgage. I probably bought too cheap a house, since I bought only what I could easily afford from the first month, ignoring the raises I'd get before the house was paid off. When I originated the loan, the lender agreed with my request that I could prepay any amount any time on the principal of the loan. I started making extra payments that I calculated to bring down the principal by some even amount, maybe a hundred dollars. Then I found some reasonably high rated bonds (American Financial 9.5's of 1988, Carl Lindner's company, rated by Fitch) selling at a discount. Buying those bonds allowed me to pay off some of the principal at about 85 cents on the dollar. I gradually bought enough of those bonds to retire the entire debt, and then a few more to enjoy the income. One of the pleasures of holding those bonds for years was watching the mounting annoyance my broker felt, seeing he couldn't churn those funds. He actually said "Get rid of those damned bonds!" at one point. (Tormenting commission-based brokers is a small but dependable pleasure.) I held the bonds to maturity and retired the mortage debt. I don't think current interest rates on mortgages and bonds allow this tactic currently, but maybe the opportunity will recur.

When I bought the second house in 2000, the funds from selling the first one were not enough to cover the purchase price. I paid cash for the second one anyway, with the help of a margin loan from my new broker (one who is salaried and doesn't care what I buy, hold or sell). I paid off the margin loan within two years, and technically the new house never had a mortgage. People speak of taking a smaller or less expensive house in retirement, maybe freeing some capital in the process. I lived below my means for so long that I could move up rather than down when I retired. (I have told this story before in here, I think. Retelling it is like playing soothing music. :lol:)

Getting rid of the mortgage in 1988 helped me accept the risk of equity investments. I went that much more heavily into the stock market, and quit working in 1993. (This was not because I was rich in 1993, but because the country elected a man who "loathed the military" and destroyed my career.) There may be a psychological benefit to you (beyond what the numbers tell you) in having your mortgage shrinking or gone. There was for me. The advice in Rich Dad, Poor Dad is reportedly that something is an asset to you only if it puts cash in your pocket, and that a house is therefore not an asset, even if you are living in it rent-free and paying little or no mortgage interest. IMO, this advice is hogwash.
He who has lived obscurely and quietly has lived well. [Latin: Bene qui latuit, bene vixit.]

Chips
peteyperson
**** Heavy Hitter
Posts: 525
Joined: Tue Nov 26, 2002 6:46 am

Post by peteyperson »

I understand most if not all of what is written in that book is hogwash.

I must have forgotten to mention in the post the psychological upside, peace of mind, being completely debt-free and not having a bank with the power to repossess a home. These are issue that may well tip the balance on this kind of decision.

Petey
therealchips wrote: The advice in Rich Dad, Poor Dad is reportedly that something is an asset to you only if it puts cash in your pocket, and that a house is therefore not an asset, even if you are living in it rent-free and paying little or no mortgage interest. IMO, this advice is hogwash.
User avatar
ataloss
**** Heavy Hitter
Posts: 559
Joined: Mon Nov 25, 2002 3:00 am

Post by ataloss »

I got serious about paying my mortgage off during the tech bubble. Would have been better off buying tips but I did't see that at the time (and had tax issues anyway)
Have fun.

Ataloss
[KenM]
*** Veteran
Posts: 133
Joined: Tue Mar 04, 2003 12:54 am

Post by [KenM] »

My first suggestion - it depends on the tax situation - not sure if the UK still has tax relief on mortgage interest payments for owner/occupiers - in the past I've not been in any hurry to pay off a UK mortgage because of losing tax advantages.

Second suggestion - from my experience, based on hindsight, it has been a mistake to concentrate on only one investment at a particular time, even though that seemed to be the most well-considered strategy at that time. Continuing diversification is the key. In today's climate, perhaps split annual investment funds 80% mortgage/20% stocks or whatever. Stocks at reasonable valuations can still be found. If stocks fall in future years then perhaps 20% mortgage/80% stocks or whatever.
KenM
Never try to teach a pig to sing. It wastes your time and annoys the pig.
peteyperson
**** Heavy Hitter
Posts: 525
Joined: Tue Nov 26, 2002 6:46 am

Post by peteyperson »

Ken,

It sounds very much like you like to hedge your bets and would recommended dollar cost averaging.

Petey

KenM wrote: My first suggestion - it depends on the tax situation - not sure if the UK still has tax relief on mortgage interest payments for owner/occupiers - in the past I've not been in any hurry to pay off a UK mortgage because of losing tax advantages.

Second suggestion - from my experience, based on hindsight, it has been a mistake to concentrate on only one investment at a particular time, even though that seemed to be the most well-considered strategy at that time. Continuing diversification is the key. In today's climate, perhaps split annual investment funds 80% mortgage/20% stocks or whatever. Stocks at reasonable valuations can still be found. If stocks fall in future years then perhaps 20% mortgage/80% stocks or whatever.
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

Your description of the Offset Mortgage, thanks to Richard Branson sounds ideal for your situation. Your business is a high risk/high return investment almost by definition. Just about all start-ups are. You are talking about combining a zero risk equity build up (i.e., early reduction of debts) and a high risk/high reward investment (i.e., your business). That is called diversification.

Think carefully about such traps as having money too easily available (similar to carrying credit cards) and overpaying for convenience. As long as you can handle those, and I think that you can, go for it.

Have fun.

John R.
[KenM]
*** Veteran
Posts: 133
Joined: Tue Mar 04, 2003 12:54 am

Post by [KenM] »

petey
It sounds very much like you like to hedge your bets
My problem is that, at your age, I didn't like to hedge my bets :(. With hindsight, if I had of hedged my bets over the last 30 years I would now be much wealthier.
and would recommended dollar cost averaging
Not necessarily .... but if, for example, you think you are interested in a diversified portfolio of business/mortgage/stocks/bonds/real estate then I would attempt whenever possible to invest (however small a sum) in several of the assets every year rather than concentrating on just one. Whatever looks logical now will probably not look the same with the benefit of hindsight in 10 years time.
KenM
Never try to teach a pig to sing. It wastes your time and annoys the pig.
peteyperson
**** Heavy Hitter
Posts: 525
Joined: Tue Nov 26, 2002 6:46 am

Post by peteyperson »

Ken,

From reading your past posts, I would have said that you like to hedge your bets, as opposed to me!

I'm just aware that taking money out of the business from profits is expensive on taxes and it is less than ideal to have to invest back those profits after paying both company tax and personal income tax to get it in the first place. Therefore, a balanced approach is called for.

Petey

KenM wrote: petey
It sounds very much like you like to hedge your bets
My problem is that, at your age, I didn't like to hedge my bets :(. With hindsight, if I had of hedged my bets over the last 30 years I would now be much wealthier.
and would recommended dollar cost averaging
Not necessarily .... but if, for example, you think you are interested in a diversified portfolio of business/mortgage/stocks/bonds/real estate then I would attempt whenever possible to invest (however small a sum) in several of the assets every year rather than concentrating on just one. Whatever looks logical now will probably not look the same with the benefit of hindsight in 10 years time.
MaiPenRai
* Rookie
Posts: 21
Joined: Mon Jun 23, 2003 3:00 am

Post by MaiPenRai »

My wife and I are under the following plan:

1. Maxed out 401k/457. We live way under our means and are planning on retiring overseas at an even lower cost of living. We reason the money we're not getting taxed on at high rate will almost certainly fall under standard deduction and low rates on withdrawl in retirement.

2. All extra cash gets put against debt in order of interest rate, with tax deuctions for mortage interest factored in. That means student loans first (we're over the income threshhold to deduct that interest) then mortgage.

So we're saving and paying off debt at the same time. We often look at it from the "bottom line" of how much our net worth changes each month or year, since both avenues affect it positively.
Cut-Throat
* Rookie
Posts: 27
Joined: Wed Jul 09, 2003 3:00 am
Location: Minneapolis

Post by Cut-Throat »

therealchips wrote: (This was not because I was rich in 1993, but because the country elected a man who "loathed the military" and destroyed my career.)


Well, I was in the Navy for 4 years and saw a lot of lifers. This was nothing more than welfare, which republicans claim they loath.

If we have kicked butt on Iraq and Afganistan maybe the Military Budget is too high and we need to reduce taxes (at the Repubs request) and you were just a casualty. Cut Government Waste - Repeat Cut Government Waste - Less Government!
TRyan
* Rookie
Posts: 40
Joined: Tue Dec 17, 2002 3:00 am

Post by TRyan »

I re-assesed the mortgage payoff question ... The issue seems easily addressed by determining what FIRE assets are needed to generate the mortgage payment.

I'll use this simple equation:

(FIRE assets needed) is (annual mortgage payment) divided by (SWR).

For example, a 15 year mortgage for $150k at 6% requires a pricipal and interest payment of $1266. That's $15192/year.

So assuming a SWR of 4% the FIRE assets needed to make your mortgage payment is: $15192 / .04 = $379.8K or 2.5 times the mortgage!

So retiring debt free means retiring earlier (by a factor of 2.5 for this example).
"Buy Low Sell High"
User avatar
BenSolar
*** Veteran
Posts: 242
Joined: Mon Nov 25, 2002 5:46 am
Location: Western NC

Post by BenSolar »

TRyan wrote: I re-assesed the mortgage payoff question ... The issue seems easily addressed by determining what FIRE assets are needed to generate the mortgage payment.
...
So retiring debt free means retiring earlier (by a factor of 2.5 for this example).

Yes, I think it's clear cut that paying off your mortgage makes a ton of sense by the time you FIRE in most cases. I can imagine scenarios, though, where keeping a mortgage would make sense.

If income producing assets were available very cheap, and if the mortgage interest rate were very low, then someone who was willing to bear a bit more risk than a typical retiree might keep the house mortgaged in order to boost income up to a level he/she could live on. Certainly now doesn't look like such a time. :)

Also, during accumulation, the low interest leverage available through a home mortgage can make sense for those who can find investments that will grow faster than the interest rate. I know I wouldn't be 1/2 as close to FIRE now if I hadn't accessed home equity to help buy well priced rentals.
"Do not spoil what you have by desiring what you have not; remember that what you now have was once among the things only hoped for." - Epicurus
Trex
* Rookie
Posts: 27
Joined: Sat Feb 22, 2003 1:16 am
Location: Tallahassee, FL

Post by Trex »

Hello All,

On the flip-side of BenSolar's comment- a mortgage free homeowner who fires in 10-15 years or so from now may have an advantage depending on rates. If this person decides to move or buy another home or whatever, they are essentially a cash buyer in a potentially (and probably) much higher interest rate enviroment. I think this would give them an advantage in a buyers market.

Trex
therealchips
*** Veteran
Posts: 174
Joined: Sat Jan 04, 2003 4:00 am
Location: Henderson, Nevada, USA

Do you want to bet on rising mortgage rates?

Post by therealchips »

from Trex:
a mortgage free homeowner who fires in 10-15 years or so from now may have an advantage depending on rates.
FWIW, here is an argument for holding a mortgage, contrary to my usual statements and personal policy: If you have an assumable mortgage at, say, 6% and you sell the house at a time when mortgage rates have risen significantly, say 8%, that assumable mortgage is an advantage to you.

Here is an (editted) example of a way to benefit from an increase in mortgage rates:
http://escrowinfo.com/aitds.html
An All Inclusive Trust Deed secures a wrap-around loan, which loan incorporates an existing loan, with a new loan made by the Seller of a property.

For example, the sales price is $200,000; there is an existing first trust deed securing a loan with a balance of $150,000, with an interest rate of 6%; the Buyer has $20,000 cash to put down; therefore, an AITD is created in the amount of $180,000 at 8%. The AITD wraps around the existing $150,000 loan at 6% and, after the sale, the Seller makes 2% on the new loan of $150,000 at 8%; the seller also makes 8% on the remaining $30,000 of the new loan. The assumable loan increases the seller's effective yield. (From 8% to 18% as I figure it.)

The Buyer makes payments based upon the $180,000 balance, and the Seller makes the payments on the existing loan secured by the first trust deed.


That isn't an interesting approach to me because I plan not to sell and I don't predict interest rates anyway. It could be a sensible bet though.
He who has lived obscurely and quietly has lived well. [Latin: Bene qui latuit, bene vixit.]

Chips
Post Reply