Today was a good day. Payed off the house and car.

[JHZR2]

Originally Posted By: FoxS
Originally Posted By: JHZR2
Originally Posted By: FoxS
I don't mind debt when its tax efficient

I have investments with a fixed income that earn more than my mortgage costs.

In fact, its a 3 to 1 ratio, so say my mortgage is $300k, that means I only need $100k of investment that pays the mortgage cost.

So I would be silly to take $300k of savings and use it to pay a $300k mortgage when just $100k of savings is earning enough to pay the $300k mortgage.

Same thing with car loans. I had enough cash to buy my Mercedes but they were offering 1.99% interest.

So long as your dont live beyond your means, and invest, borrowing can save you money. In fact, its what the very rich have been doing for a long time on many ways.


A $300k loan with a 1.25% tax rate and 3.3% interest on a 30 year loan is like $1625/month. That is $19500 per year out of pocket.

So youre saying that your $100k investment is yielding roughly 20%, and in reality, a bit higher, because of taxes???? Yeah, right.

And your $100k that just bought you a $300k home at the end of 30 years would be $38 Million if compounded monthly at a 20% annual yield.

Heck, your $100k yielding 5% would be $446774 after 30 years...

Of course, you mention tax advantage, so how about this... You probably get 32c on the dollar in terms of tax advantage... You pay the bank $1 in interest and get 32c back on your taxes. Ill do one better... If you give me $1 today, Ill give you a whole 50c back on April 15. A whopping deal. Feel free to send the whole 100k youre sitting on for that deal. Its a good one compared to a tax refund.

There can be benefit to leverage, but the returns on low risk these days, a market hitting a top, bond market ready to bust as soon as interest rates start to rise, etc., means that sitting on money is just silly. On an investment, in some cases, there may be benefit... Not this.


So I have a mortgage that has an interest rate of 2.5% before tax deduction. A marginal tax rate of 40% (state and federal). So the cost of my max $1million mortgage is $15k a year or 1.5%.

I took out municipal bonds with a yield at the time of 4%. This was when the market was scared that state and local govts would go bankrupt. This return is tax free. The yield now is lower and I've actually made a decent capital appreciation on the investment but the yield on my original investment is 4% tax free.

4% investment return is 2.67 times my mortgage interest rate of 1.5%. For a $1million mortgage I need only $375k in an investment that earns 4% after tax.

I actually have a set up pretty much like this. My fixed income investment is paying my mortgage interest. I then save a larger portion of my income which I invest in other vehicles.

If you know what you're doing from a purely financing perspective, its makes it easier to build your net worth. There is no way I am paying any part of this mortgage off any faster than I need to.


So do tell what kind of a funky mortgage you have that you can pay it off over 30 years and have $1M (jumbo+) at 2.5%.

The rates never went that low. Perhaps you paid a ton of points? It also sounds like youre paying no principal... So what do you have? A 30 year interest only Jumbo?

Inquiring minds want to know.

 

[PandaBear]

Originally Posted By: JHZR2


So do tell what kind of a funky mortgage you have that you can pay it off over 30 years and have $1M (jumbo+) at 2.5%.

The rates never went that low. Perhaps you paid a ton of points? It also sounds like youre paying no principal... So what do you have? A 30 year interest only Jumbo?

Inquiring minds want to know.


It is not the market rate, famously famous people (i.e. Mark Zuckerberg) gets 1% interest rate mortgage that you and I will never get.

If he does get 2.5%, it would likely be something with an impound for property tax and insurance, and he has to have some W2 income to back up the stability, and at a very short term (i.e. my 10 year fixed, instead of a 30 year fix). Lenders do not like self employment or income from businesses, they like paychecks. They also would likely demand that you have very large equity (i.e. more than 40%) and income to debt ratio before they'll consider a 2.5% interest rate loan.

If you are trying to max out your mortgage to finance a bond, lenders would likely charge a very high interest rate that make this hedge or swap unprofitable.

 

[Vikas]

Was there ever a time period when tax free municipal interest rate was higher than mortgage rate? Can somebody find a bank paying higher interest on your CD than the loan APR?

I suspect he is talking about hypothetical situation to make his numbers work but they will never work in real life.

 

[JHZR2]

Originally Posted By: Vikas
Was there ever a time period when tax free municipal interest rate was higher than mortgage rate? Can somebody find a bank paying higher interest on your CD than the loan APR?

I suspect he is talking about hypothetical situation to make his numbers work but they will never work in real life.


+1

 

[FoxS]

I have nothing to gain by saying such numbers work for me if they didn't. They do happen to be true.

But my wider point is that it is quite easy to beat the current after tax mortgage rate, so why would anyone pay their mortgage down right now?

Forget about return from munis, plenty of stocks are returning 3%+ dividends with capital growth prospects.

PandaBear himself said he got a great rate on a 10 year fixed. There is an example right now where the return on munis still easily beats a current mortgage interest rate net of tax.

 

[JHZR2]

Yeah, there are stocks yielding well with some growth potential. A variety of places to make return.

But then youre sacrificing substantial compounding opportunity in the interest of paying a mortgage slowly.

Remember my numbers from before, the 100k yielding a mere 5% compounded over 30 years is 447k.

Instead, youre letting the mortgage compound their interest, while you get no advantage. So at the end of 30 years, you just paid well over $400k in payments and interest, and are stuck with the same $100k, which after inflation is only good for $60k worth of buying power.

It still doesnt add up to me. I want to get to the point as quickly as possible where my salary can be added to the principal in my investment accounts, and so not only am I compounding dividends, but also adding money in to yield me ever more.

Being tied to payments on anything, real property that theoretically increases in value included, limits your ability to throw substantial dollars towards saving and multiply the already powerful compounding going on.

 

[Mr Nice]

I have to agree 100% with JHZR2 way of thinking.

 

[FoxS]

Originally Posted By: JHZR2
Yeah, there are stocks yielding well with some growth potential. A variety of places to make return.

But then youre sacrificing substantial compounding opportunity in the interest of paying a mortgage slowly.

Remember my numbers from before, the 100k yielding a mere 5% compounded over 30 years is 447k.

Instead, youre letting the mortgage compound their interest, while you get no advantage. So at the end of 30 years, you just paid well over $400k in payments and interest, and are stuck with the same $100k, which after inflation is only good for $60k worth of buying power.

It still doesnt add up to me. I want to get to the point as quickly as possible where my salary can be added to the principal in my investment accounts, and so not only am I compounding dividends, but also adding money in to yield me ever more.

Being tied to payments on anything, real property that theoretically increases in value included, limits your ability to throw substantial dollars towards saving and multiply the already powerful compounding going on.


Yikes!

You know how banks make their money right? They borrow money at a lower rate than they lend it out (plus they are allowed to lend out x times what they borrow).

If you have 2 credit cards which you have been unable to pay in full, which one do you pay down the most? The one with higher interest.

Same concept with borrowing and investing. If you can get higher return on your money than it costs to borrow, then why pay off your borrowing. You're confusing yourself with talk of compounding and inflation. Your comparison is not like with like. Isn't your principal eroded by inflation too while your salary keeps up with inflation? The only comparison you need to make is net interest rate vs net interest rate.

Think about it. I earn a salary and pay my mortgage. Anything that is not interest is a payment to myself. If I have a 375k safe investment that perpetually pays the interest on a $1million mortgage, then my salary is all savings!

Why would I put that $375k into the mortgage, zero out the interest income from it and still have two thirds of my interest expense payable which now HAS to come out of salary?

 

[PandaBear]

Originally Posted By: JHZR2
Originally Posted By: Vikas
Was there ever a time period when tax free municipal interest rate was higher than mortgage rate? Can somebody find a bank paying higher interest on your CD than the loan APR?

I suspect he is talking about hypothetical situation to make his numbers work but they will never work in real life.


+1


I don't think he is talking hypothetical, but different rate at different time. So let's say he had a mortgage at 6% and bond at 4%, now he refinance the mortgage at 2.5%, that would be a 1.5% gain. In theory he is making more money risk free by not paying off his debt early.

In practice, he could sell his bond early off in the market to cash out on the yield early, instead of making the same interest tax free he would make a one time taxed income. If you look at this strategy as an opportunity cost, he would still be making less money by having both a bond that is lower yield (market rate) than his mortgage that he could have pay off early and with a taxed income.

It is all about how you look at the accounting side of it and what gives you a warm and fuzzy feeling, and how much you trust the investment leverage and hedge to be "risk free".

 

[PandaBear]

Originally Posted By: FoxS
Same concept with borrowing and investing. If you can get higher return on your money than it costs to borrow, then why pay off your borrowing. You're confusing yourself with talk of compounding and inflation. Your comparison is not like with like. Isn't your principal eroded by inflation too while your salary keeps up with inflation? The only comparison you need to make is net interest rate vs net interest rate.

Think about it. I earn a salary and pay my mortgage. Anything that is not interest is a payment to myself. If I have a 375k safe investment that perpetually pays the interest on a $1million mortgage, then my salary is all savings!

Why would I put that $375k into the mortgage, zero out the interest income from it and still have two thirds of my interest expense payable which now HAS to come out of salary?


As I've said before, there are risks in hedging because not all part of the equations are balanced at all time. Even Credit Default Swap can default on its promise to pay you for the investment you hold, and we were very close to that in 2008 if we did not bail out AIG (I'm not trying to make it political here but this is the truth in financing, the reason we bail out AIG is because we do not want every single transaction that was hedged with a CDS type insurance to fail and collapse every company out there).

Also in your example, you do understand how banks go out of businesses right? They borrow money and invest in the wrong investment that default on their deposit / loans, so they are on the hook for the equation that is not balanced.

The value and the return of your investment is directly tied to the risk. Our bankruptcy law protect your paid off home from being taken away, so when you are hedging a mortgage on an investment, no matter how small the risk, you could lose a chunk of it, and if your hedge is big, you could lose your equity in the house (foreclosed to pay off the difference).

Once upon a time (when Warren Buffet was young), government bond is considered low to no risk, look at how many of them got written off due to default or renegotiation in the last 5 years?

So it is not a question of "why would anyone pay off their mortgage early instead of investing", but "how much extra yield should I make to justify taking on this risk". And this depends on the borrower's credit rating (hence mortgage interest rate) and his income to debt ratio. I can guarantee that if your income to debt ratio is high because of running these hedges, your mortgage will not be the lowest, thus erode some of the potential income from your equation.

 

[FoxS]

PandaBear, you make valid theoretical points about risk.

There are 3 points though.

1) After tax my borrowing rate is 1.5%. That's insane right? If I'm not going to invest when my borrowing rate is 1.5%, when would I invest?

2) My muni funds have thousands of investments. The risk of default making any difference is tiny. I have some stock in PG. It has not been growing hugely but the dividend has been growing at 5% a year for 15 years and the yield is 2.9% right now. If PG stops growing as a company, it becomes a risk adjusted bond. The risk in PG going bankrupt is tiny. The lower end of outcome easily beats the mortgage rate.

3) The higher your net worth, the more this strategy becomes financial optimization vs risk. I don't even understand why you feel having a lower mortgage and no investment is better than a higher mortgage and investments. Only if you get the mortgage to zero are you at lower risk and you can build the investments to the balance of your mortgage faster if you invest rather than apply those funds to capital reduction. Also, you can place investments in trusts to shield them from bankruptcy.

Once you build a certain amount of income producing / capital appreciating investments and if you are fortunate to have a 2.5% interest mortgage, you have a good buffer if something comes up that for others might lead to bankruptcy.

I can actually pay off my 1.5% after tax mortgage but I'm not going to. Indeed, I have an investment mortgage that is going to increase to 4% that I am considering paying off instead. Even at that cost of borrowing I am wondering whether to go ahead as it gives some tax advantages also so is not actually costing 4%.

 

[kkreit01]

Very nice. I won't know that feeling -- unless I hit the lotto (and I don't buy tickets).

 

[Vikas]

What are the typical bond terms? I was not aware of very long term (aka mortgage years i.e. 15+) bonds which theoretically could have had purchased when the interest rates were high.

A real URL for 4% muni and 2% mortgage would answer my question.

 

[wtd]

Some interesting information in this post. I was not in any of the above situations and I was at the end of my loan so not paying off my mortgage a little early would not have helped me.

I sometimes question whether buying a home is a wise investment unless you live in an area that the value of homes goes up rather quickly like they used to do on the west coast.

In 1992 I payed $59,900 for my house. At the time, I figured up that if I payed my then monthly mortgage payment for the original 30 year loan, I would have payed around $192,000 for my house. In the area that I live in, my house will never be worth that much. Off hand I don't know how much I've paid for the almost 21 years that I did pay, but I bet it was still much more than my house will ever be worth.

Brand new houses, comparable to mine in size, are only going for around $110,000 right now My house in this current market would probably only be worth in the high 90's if I was lucky.

The bottom line is that I payed way more to own this house than what it will ever be worth. Granted, for a lot of years I got a tax benefit from owning the house and I had to pay to live somewhere so I may as well have put it toward me rather than someone else, but whether or not it was a profitable investment, that is up for debate.

Since I currently live with my fiance, at some point I may turn my house into a rental that may start paying me back depending on if I get the right renters but that is a whole different story.

Wayne

 

[PandaBear]

Wayne,

I think you need to look at it this way: you need to live somewhere and if you do not own a home you have to rent, so the rent should be compared against interest payment (not principal) + insurance + property tax + maintenance. You also cannot compare your 90k home price vs the 180k total payment over the year, because money is not a fixed number, but is a number that can only be compared at the same time frame.

So you can compare a 90k house's total 30 year payment of 180k with, an investment you could have made with 90k for 30 years after you have subtracted your housing cost , and see if that come close. My guess is, unless you have a plan to live with your parents or rent just a room off some family, a huge chunk of that 180k payment is covering the "rent" equivalent of your housing need.

Say your rent would have been $500 if you rent a similar house, for 30 years that would be $180k in today's dollar. Your $180k total mortgage payment + tax + insurance - this $180k rent equivalent gets you a 30 year old house that is paid for (assume $60k to buy a house 30 year older than when you buy it), it isn't that bad of a deal.

But, you do have a lot of uncertainty in life and a mortgage is like an anchor that lock you down financially and geographically. It is much harder to relocate far with a house.

 

[PandaBear]

Originally Posted By: FoxS
PandaBear, you make valid theoretical points about risk.

There are 3 points though.

1) After tax my borrowing rate is 1.5%. That's insane right? If I'm not going to invest when my borrowing rate is 1.5%, when would I invest?

2) My muni funds have thousands of investments. The risk of default making any difference is tiny. I have some stock in PG. It has not been growing hugely but the dividend has been growing at 5% a year for 15 years and the yield is 2.9% right now. If PG stops growing as a company, it becomes a risk adjusted bond. The risk in PG going bankrupt is tiny. The lower end of outcome easily beats the mortgage rate.

3) The higher your net worth, the more this strategy becomes financial optimization vs risk. I don't even understand why you feel having a lower mortgage and no investment is better than a higher mortgage and investments. Only if you get the mortgage to zero are you at lower risk and you can build the investments to the balance of your mortgage faster if you invest rather than apply those funds to capital reduction. Also, you can place investments in trusts to shield them from bankruptcy.

Once you build a certain amount of income producing / capital appreciating investments and if you are fortunate to have a 2.5% interest mortgage, you have a good buffer if something comes up that for others might lead to bankruptcy.

I can actually pay off my 1.5% after tax mortgage but I'm not going to. Indeed, I have an investment mortgage that is going to increase to 4% that I am considering paying off instead. Even at that cost of borrowing I am wondering whether to go ahead as it gives some tax advantages also so is not actually costing 4%.


As you have already pointed out, your portfolio is tax adjusted and include stocks, and you are making assumption of your return base on past performance. You also assume that everyone can get the same 1.5% tax adjusted rate you are getting, which IMO is unlikely as the "market" rate is around 2.5-3.5% right now for the typical mass.

The rest of your argument is about risk management: how to spread the risk out. While it is unlikely that you will end up with a bankruptcy because your entire investment portfolio is wiped out and you lost all the equity in your home, it is nevertheless an investment with risk and should be priced accordingly.

Remember if you really want to price the investment right, you have to add the cost to insure in there (i.e. the cost of CDS or options to protect your stock from dropping below a certain point).

 

[wtd]

Pandabear,
I understand what you are saying and I did reference that in my post. I paid $59,900 for the house initially, not $90,000 and with the interest and equity over a 30 year period, I would have paid around $192,000 total for the house. This doesn't include the almost $1,000 a year in property tax I pay. So with that added in I'm at around $220,000. That is over three times my original purchase price.

The bottom line is a house is probably the most expensive purchase a person will make and it's nice to be out from under that finally.

I have a pretty secure job so I'm not worried about losing it but if for some reason I did, at least I would still have somewhere to live(if my fiance and I split for some reason) and wouldn't have to worry about being forclosed on or being put out on the street. That is a good feeling right there.

Wayne

 

[FoxS]

Originally Posted By: Vikas
What are the typical bond terms? I was not aware of very long term (aka mortgage years i.e. 15+) bonds which theoretically could have had purchased when the interest rates were high.

A real URL for 4% muni and 2% mortgage would answer my question.


I am sure you can find a muni bond fund from any number of providers and see that the current rate is in the low 3% range. When I got in, they were at 4%. There were times that the yield was higher.

PandaBear just refinanced to a mortgage that would give something in the 2% range after tax.

Yes a lot of this is about timing and having enough wealth to move between borrowing and investing as rates move.

As to risk of investing, folks like Fischer investing will invest for you if you have $500k and they are quite conservative yet beat mortgage rates consistently.

 

[JHZR2]

Originally Posted By: wtd


In 1992 I payed $59,900 for my house. At the time, I figured up that if I payed my then monthly mortgage payment for the original 30 year loan, I would have payed around $192,000 for my house. In the area that I live in, my house will never be worth that much. Off hand I don't know how much I've paid for the almost 21 years that I did pay, but I bet it was still much more than my house will ever be worth.


This is a prime example of why 30 year mortgages, despite the supposed "security" are bad deals. It is Al's the prime example of why I disagree with foxs approach.

As you can see, the amount paid for the house is far more than the original purchase price. Why? Compounding. Regardless of interest rate, this happens, and the Interest is some multiple of the home value.

Long terms increase lender risk, so drive higher rates. higher rates, longer terms, more compounding, lots of money paid. No way out of it. Shorter durations are lower risk, lower cost, and more principal is paid off sooner. You end up paying a LOT less interest.

Foxs also doesn't really cover the principal in his claims. While I'm sure it's in there somewhere, I dont know the amortization schedule. But remember, it still is a matter of lost compounding on the assets you own, while the mortgage still compounds over a very long time.

Yeah on paper if you yield 4% and pay 1.5%, you're making money. Heck, maybe you can cover interest and principal with the delta. But you've just gotten the double whammy on compounded interest because you're. It compounding on your assets due to pulling the money to pay the mortgage, and the mortgage is consistently charging interest on a very high principal that is reducing very slowly.

In my mind, you want to pay as little for the borrowed money as you can, so that you can ultimately get compounded returns and new money flow into your investments, for as long as possible.

As you show in your example, time is NOT on your side here, but it would have, had you had such money in the bank and allowed the principal to compound.

 

[PandaBear]

Originally Posted By: JHZR2

Yeah on paper if you yield 4% and pay 1.5%, you're making money. Heck, maybe you can cover interest and principal with the delta. But you've just gotten the double whammy on compounded interest because you're. It compounding on your assets due to pulling the money to pay the mortgage, and the mortgage is consistently charging interest on a very high principal that is reducing very slowly.


Originally Posted By: FoxS

Yes a lot of this is about timing and having enough wealth to move between borrowing and investing as rates move.


Actually, to FoxS' defense, he is covering everything.

What he was doing is actually using a house as a collateral to borrow money to "invest", while living in it. It is a leverage that not every investor could take advantage of, because the interest rate would not be low if your borrow a lot, do not live there, have other debts, or has a low STABLE income to debt ratio. Banks are not stupid, they won't give you a low interest if you are just borrowing their money to flip stocks, they'll do it if you are not borrowing a lot and you can pay it off quick.

Both the interest of the investment income and the mortgage payment is compounded, but the investment income is not fixed and is an estimate from past performance.

I've already covered the potential "black swan" that can collapse his investment and foreclose his house. He believes that it is a disregard-able risk.