How low would the interest rate on your debt need to be in order for you to change your mind?
My main reason for doing so is that N=23 provides a much more reliable estimate than using N=1, plus it’s so easy these days to invest in broadly diversified international funds/ETFs that all developed markets should provide similar returns going forward. But I agree that past returns have limited predictive value, just better than pulling a number out of your ass like 10%.
4% for equities is a reasonable (although I wouldn’t say it’s conservative) estimate for future returns. That approaches what you would obtain whether you used the Gordon formula, Shiller’s P/E10, Tobin’s Q, E/P, or similar methods.
There are literally dozens of investments that can beat the return I would get by paying off my mortgage. Hell, both the 10 and the 30 year US Treasury yields beat the interest rate I’m paying on my mortgage with minimal risk, not to mention a host of equities if you’re willing to face a little more risk.
Paying off your house isn’t necessarily risk free either. What if the housing market collapses? Suddenly you’ve just invested $100,000 in an asset that’s worth half that. What happens then?
Is one’s position substantially improved if they owe $100k on a $50k house? I suppose there’s the option of foreclosure / bankruptcy?
In that event one’s position would be substantially improved by owing $100 K on a $50 K house while having a $100 K portfolio.
Why? One’s net worth is still $50k in either scenario, right?
The two scenarios being:
A) Paid-for $50K house, no other assets
B) $100K mortgage on a $50K house, but $100K in other investments
And that’s assuming that one’s $100K portfolio maintained its value while the housing market was crashing. That might be possible, but it certainly didn’t happen last time the housing market crashed. A more realistic scenario for B) might be a $100K mortgage on a $50K house and $50K in other investments.
I’m assuming the third option being foreclosure, with no mortgage, no house, no credit, but still $100k in other investments.
Would the bank that held the mortgage not pursue their debtor for the other $50K if the debtor had $100K in other investments?
It depends on the state and the terms of the mortgage but, in many cases, the mortgages are non-recourse loans and the lender can’t go after any of the borrower’s assets other than the house.
In non-recourse states; Alaska, Arizona, California, Connecticut, Florida, Idaho, Minnesota, North Carolina, North Dakota, Texas, Utah, and Washington the bank has no recourse beyond seizing the property. Hence the term.
In addition to the comment about recourse / non-recourse states:
Money saved in workplace retirement accounts is generally not touchable by lawsuits / bankruptcy (I don’t know if there are any cases where one could be forced to withdraw recent contributions; I’ve heard that it CAN happen with just an IRA).
So, while I don’t recommend borrowing against the house to fund your investing style, there’s an argument for putting the 100K into your workplace plan instead of paying down the mortgage.
Me: if I had a sudden 100K, and ignoring the issue of other debts, I’d absolutely do whatever I could to get the money into my 401(k) - in fact, when we had an inheritance, that’s basically what we did (bumped up the withholding and used the cash to cover the income shortfall).
We’ve got our investments in a mix of stuff that is heavy on the stock-based mutual funds, though gradually tweaking the ratio toward a little more bond / cash equivalents as we get closer to retirement.
That’s true, another serious complication due to tax policy when it comes to whether or not to pay down debt. A trad 401k or IRA is giving a tax deduction which is limited to the current year, you can’t make up for it if you skip it to pay down a mortgage. Even the Roth version of either is giving a future tax benefit of tax free withdrawal after tax free compounding. Moreover an employer (as opposed to individual, for self employed) 401k is usually providing a matching employer contribution up to a certain level. Leaving that money on the table almost never makes sense if it’s possible by almost any means to make a contribution at least up to the employer match limit.
Also the point about non-recourse v recourse mortgages needs to be considered. Though I live in a recourse state.
But I think even with all factors considered there’s a tendency overall to view mortgage debt overly positively, it’s sort of baked into US culture somehow. People seem to often make cherry picked comparisons.
For example if somebody took out a mortgage at the bottom of the recent rate cycle and is comparing it to low risk bond rates now, good for them but that’s not an apples to apples comparison. Right now the 30 yr mortgage rate is around 4.5%. That’s for an average life of around 18 yrs. The 18yr point on the treasury curve is around 2.95% or so. That’s a significant negative* to borrow at the mortgage rate and invest risklessly. A bank is taking risk lending to you even with the house securing the loan. You’re taking essentially no risk lending to the federal govt. Why would that come out positive unless you cherry picked by taking rates at different times?
And as discussed previously, a reasonable estimate of the expected return of stocks now, at these lofty valuations, might be something like 6.5% nominal. Even with deductibility of the full mortgage interest and taxation of only the dividends flow on the stocks (in a taxable account, again assuming the 401k contribution is maxed out) that’s not no-brainer territory that it makes sense to finance stock purchases in taxable accounts with a mortgage you could afford to pay off. Pretty far from it IMO, though it is a matter of risk preference as long as the expected return is actually higher on the asset you’re financing, not lower like it would be with treasuries.
another caveat here is state tax. The mortgage interest is usually deductible for state tax (though it’s not in NJ where I live). The treasury interest is not state taxable anywhere. So in a state where that’s true, at 5% state tax rate and assuming 25% for a federal tax rate, the after tax negative carry is (2.98%(1-.25)-4.5%(1-.30))=-0.91% whereas here in NJ it would be just (2.98%-4.5%)(1-.25)=-1.14%, but it takes a much higher (deductible) state tax rate to make it positive.
No kidding… it sounds like he’s from the “Debt is the devil!” mindset, where owing anyone anything is perceived as the worst possible state of affairs and one to get out of as soon as possible, regardless of the cost.
I can use an example of a debt worth keeping- my student loans. I consolidated my loans about 14 years ago at something like 1.6% interest. I owe something like 10k at this point, and for argument’s sake, let’s say I still have 10 years to go. (I think it’s more like 6 in reality).
Now if I don’t pay it off, I’ll end up paying something like $10900 over the next 10 years. In other words, I’m paying $900 over 10 years for the privilege of not paying the $10000 off immediately.
If I got $10000 in some kind of windfall, I could pay that debt off right away. Let’s say for the sake of simplifying things, that that $10000 would pay it off in full (probably not the case in reality). At the end of the 10 year period, I’ll have $10900 that I wouldn’t have had otherwise. Bonus!
But… if I take that $10000 and invest it in something making say… 5%, I could make a little less than $16300 over that 10 year period.
So if I paid the debt off immediately, I’d save myself 900 dollars I’d have paid in interest. But if I invested the $10000, I’d make 6300 dollars, for a net gain of $5400. Either way, $10,000 is going into the student loan.
That’s why it’s a better idea financially to keep the debt and invest the windfall elsewhere.
I had my mortgage paid off. Then I bought a second home (my brother in law had terminal cancer and it was for him). I took out a mortgage for that - but I did it against my primary residence. When I sold the little house, I paid down some of the mortgage on my house - but put most of it into a variety of stocks and refinanced the rest of the mortgage.
The stocks have an average dividend of (when I bought them) 5%. The interest rate on the mortgage is less than 4%. I’m in a 35% marginal tax bracket, so that reduces my real interest rate. The dividends have not decreased and the stock has remained - at the worst - stable over the past six years. The mortgage is for 30 years. I have a net after taxes mortgage of about $200 a month, and a dividend that averages about $300 a month - and that compounds while the mortgage gets ever so gradually smaller.
So I was debt free, but now I have debt again because having debt adds more to my income than not having debt.
It does add risk and isn’t something that should be done unless you can afford the risk. But if the stock market crashes enough that it matters (my relative exposure is fairly low), as I said, we are in a Mad Max world, and I have bigger problems.