I have to admit that my wife tripped me up on the topic of early payoff vs investing.

Background: We've got a 3.5% 30 year mortgage and I refuse to pay more than the minimum payment each month because it isn't hard to beat that rate in the stock market. My wife, on the other hand, despises debt and wants to pay everything off as quickly as possible.

I was trying to explain the math to her and she threw it right back in my face and said, "If you can make so much more in the stock market, why don't you pull out all of the equity you can an invest it all?" I found myself in a position where logically, I agree with her, but I just can't swallow the idea of pulling out the equity that I've built up.

Do any of you actually follow the math and take the equity out of your home to invest?

There are risks either way. If you put all your money and home equity in the stock market, and then lose 30, 40, 50% percent in a downturn.... is that within your risk tolerance? Is it within your wife's risk tolerance? You guys need to be on the same page.

Paying down debt is a guaranteed boost to your net worth. The market offers better opportunities for growth with the extra risk attached to it. Caveat: I'm not a financial counselor, just a regular Joe.

It doesn't have to be an all or nothing decision either. I have a largely variable income stream so we made a priority list from first goal to final goal.

It goes something like this (while maxing out retirement):

1. Emergency Fund
2. Down Payment on a House (20%)
3. Non-Retirement Savings for a certain amount. We take value increases and decreases into account as well to reach the target and if the market falls after reaching it we will go back to this goal.
4. Increase Equity on House to 50%
5. Fund Kids College Education
6. Non-Retirement Savings 2 for a certain amount.
7. Down payment on a Rental Home
8. Increase Equity on House to 75%
9. Down payment on a Rental Home #2
10. Non-Retirement Savings 3 for a certain amount
11. Payoff House

It works well for us. We might use Non-Retirement Savings to buy a car and then try to fund it back as quickly as possible. We know that the further down the list we get the more financially secure we are as a family. It also gives us comfort that we are spreading our risk between our home and investments.

Agreed Ragoo

Pay off the mortgage . Yes, 3.5% is a really good rate that can be beat. But the delta is going to be like 3.5% to 4% before any taxes and after taxes it's really not worth the risk. On the other hand having no debt is as secure of a position as you can be in. Remember the old saying, "if you owe the bank $100, you work for the bank. If you owe the bank $100M they work for you." If you can avoid being indebted to banks for the things you have in your life you should. I'm by no means a Dave Ramsey guy, in fact other than respecting the fact that he gets paid to sell common sense I don't have much use for him. But in this kind of situation where you're choosing between completely debt free and something else I think you get the debt paid off.

I agree with what others have said, it all depends if you invested the difference of what money you'd throw at the mortgage in an effort to pay off the loan.

Personally, I think paying off the mortgage (after maxing out retirement) is a smart thing.

You are right, the equity invested into the S&P over a 10 year period would likely get you a gain that'd eat up the 3.5% interest that you owed, but that'd be assuming that the income you would use to pay off the house is all going towards the market. I feel like maxing out retirement and trying to pay off the house would be the less risky move.

It also could depend where you live and how long you are going to live there. I'd imagine if you were living in one of those nice WASPy north Dallas areas, then the rate of return on your equity is probably through the roof.

Some people like to bash Ramsey, but I actually agree with him whole heartedly. The best part is, once you stop allowing that 3.5% to eat at your income and returns, you can invest that difference.

Common sense dictates that no debt is better than having debt, but I will say, I absolutely do see your point.

I am in the same boat. I have a decent amount of savings I'd like to invest and a new homeowner. I look at my amortization schedule and the interest is so heavily loaded on the front-end I'm so tempted to work to pay that down so more of my money starts to go to principal. There's a balance that I'm trying to figure out.

DallasAggie0 said:

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I am in the same boat. I have a decent amount of savings I'd like to invest and a new homeowner. I look at my amortization schedule and the interest is so heavily loaded on the front-end I'm so tempted to work to pay that down so more of my money starts to go to principal. There's a balance that I'm trying to figure out.

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it is called buying a house you can comfortably fit within your cash flows on a 15 year mortgage. Your principle is always greater than the interest.

I just pulled some cash out of my house for this reason. There was no way to do the math where it didn't make sense. I stayed below 80%, but now I have a fairly significant chunk of cash to play with.

Sounds like you have a great wife. I used to be against debt and would say pay it off. I've come to realize that you never truly own your home due to property taxes. If you aren't sure about tapping the equity, you might consider a line of credit. If you decide to use it or never use it you have it in place as an option.

I think you may be forgetting that in scenario A you also get to invest that mortgage payment. $1,000/month at 7.5% is going to get you close to $190k.

The delta is much smaller than you are proposing. And in scenario A you have much less risk.

Less risk, yes but 6x the return before tax considerations. I'm not sure what you mean "get to invest the mortgage payment". This is two scenarios using a one time $100K windfall. The numbers are similar for slow-drip investing/loan payments.

How about a hybrid-compromise: Keep investing but every 5 years or so, use half the gains for extra mortgage payments? This has the benefit of:

1) Keeping the wife happy with a plan for the debt.
2) Allows compounding time to ride a bull market cycle.
3) Extra payments won't eat into budget (are "free").

John Maplethorpe said:

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Less risk, yes but 6x the return before tax considerations. I'm not sure what you mean "get to invest the mortgage payment". This is two scenarios using a one time $100K windfall. The numbers are similar for slow-drip investing/loan payments.

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If you pay off the mortgage in your 1st scenario, then you have 1k monthly cashflow increase to invest with.

I did a 30 year mortgage with 3.5% interest. I have also maxed out my retirement. After budgeting my living expenses, I expect to pay that thing off in the next 2-3 years.

I think, in my case, it is worth paying off the mortgage at lightening speed. Speaking within a 10 year span, then you might be right, but in the short term we'd have no way of knowing what the market will do, but I do know that I can add more equity to my home (and net worth) by doing it this way. After the three years are up I will not have a 3.5% interest eating at my income and I will be investing the difference.

Could the market beat the 3.5% interest in that 3 year period? Sure. Will it? Who knows? Probably. But missing out on just three years of returns (that I'd subtract 3.5% from) and then investing the difference over the 30 year span I think I'd come out ahead; without having to continually subtract the 3.5% off of my returns over that 30 year (or in this case 27 year) span.

Basically it'd be returns over a 27 year span

or

Returns over a 30 year span subtracting the 3.5% from average annualized returns.

After running a few numbers, worst case scenarios for the 27 year span and the 30 year span, I found (again worst case scenario from past markets):

27 year span would be a 9.03% return.
30 year span would be a 10.52% return minus 3.5% which would equal 7.02% returns.

So as some others were saying, it really depends on the amount of money you are going to invest. If you could pay off the mortgage quickly then invested the difference it would likely be worth your while.

goodman said:

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I think you may be forgetting that in scenario A you also get to invest that mortgage payment. $1,000/month at 7.5% is going to get you close to $190k.

The delta is much smaller than you are proposing. And in scenario A you have much less risk.

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Actually just ran the numbers:

Scenario A: Invest 100k after 10 years

Asset:
Investment - 211k
House - 100k (assume no growth since you own the house in both scenarios)

Liability

Mortgage - (78k)

Net Position - $233k

Scenario B: pay off house - not sure where the 983 payment he got came from as P&I is only 463 for 30 yr mortgage at 3.75% on 100k. You still have insurance and property taxes regardless of paying it off

House 100k
Investment: 463 per month at 7.5% - 82K

Net: $182k

So about 50k better off over 10 years. Seems reasonable based off the increased risk of investing vs. paying of house.

That isn't the correct way to look at it. A very high percentage of the time, it will be better to invest extra money over 30 years vs paying it off and then investing.

It is just a matter of understanding how compounding works or seeing it work through a real hypothetical. A 10% return on $1 million and then accounting for the interest charged on the mortgage is not the same as 7.5% on $1 million.

In your example, you need to run those returns with the monthly amounts that will be invested for it to become more obvious.

Here is a minor example:

invest 1k/mo for 30 yrs at 10% and you get $1.9mm. Interest cost is $200k. So still profit a lot.

invest 1k/mo for 27 yrs at 9% and you get $1.2mm and no interest cost.

The example still isn't correct for the OPs decision, but it does help explain how compounding works, and how taking 3.5% off of 10% isn't the correct way to look at the numbers.

Harkrider 93 said:

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That isn't the correct way to look at it. A very high percentage of the time, it will be better to invest extra money over 30 years vs paying it off and then investing.

It is just a matter of understanding how compounding works or seeing it work through a real hypothetical. A 10% return on $1 million and then accounting for the interest charged on the mortgage is not the same as 7.5% on $1 million.

In your example, you need to run those returns with the monthly amounts that will be invested for it to become more obvious.

Here is a minor example:

invest 1k/mo for 30 yrs at 10% and you get $1.9mm. Interest cost is $200k. So still profit a lot.

invest 1k/mo for 27 yrs at 9% and you get $1.2mm and no interest cost.

The example still isn't correct for the OPs decision, but it does help explain how compounding works, and how taking 3.5% off of 10% isn't the correct way to look at the numbers.

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I only ran my own numbers. I did invest the difference on the amount that I am putting towards the mortgage now over that 27 year period.

You are right though, I didn't take into account the interest payments going down and the extra getting added to principle so subtracting the 3.5% from the 10% wouldn't be accurate but now you've got me even more interested in what the actual numbers would be because I'm not so sure it'd only be a $200k cost in interest. I feel like the numbers should be closer than that.

Some people like to argue the extremes rather than the means. Look at her question somewhat differently....If I'm relatively young why wouldn't I necessarily want to be 100% in equities with no equity in the house. Does that meet your diversification criteria related to risk? Maybe, maybe not.

Nothing is necessarily risk free but when you are younger, the equity in the house can be a source of portfolio diversification in the earlier stages of throwing lots of money into growth stocks for your retirement and non-requirement accounts.

For some of us old enough to have signed mortgages with double digit interest rates, paying it down was a no brainer. At 3-4% interest rates on the house it can be more to do with how I feel related to risk and diversification of the portfolio rather than what the spreadsheet shows.....as long as I think about a realistic discussion of risks either way.

goodman said:

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John Maplethorpe said:

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Less risk, yes but 6x the return before tax considerations. I'm not sure what you mean "get to invest the mortgage payment". This is two scenarios using a one time $100K windfall. The numbers are similar for slow-drip investing/loan payments.

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If you pay off the mortgage in your 1st scenario, then you have 1k monthly cashflow increase to invest with.

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Yeah I see now. Here's the if you invest that $986 mortgage payment the scenario looks like this after 10 years:

Invest $100K @ 7.5% = $211,206 total after 10 yrs(including principle)
Pay off mortgage invest $988/mo = $175,948 total after 10 years

So the delta is $35,258. If you up the horizon to 20 years, the delta is $71K in favor of investing. That's a 3.55% better return than paying off.

I think it comes down to the fortitude of your stomach.

There's a possibility that If you invest as a lump sum right now, and the market corrects and drops a significant percentage. This is the second longest bull market in history. At some point, a correction will happen.

If you work on paying off your house, you have that debt retired, then apply the mortgage payment to investing. Your investment is now spread out over time as you make monthly buys.

Yes, you may indeed lose out on some compounding interest, but it carries a greater risk. Depends on your age, risk tolerance, and how soon you might need the money.

John Maplethorpe said:

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goodman said:

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John Maplethorpe said:

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Less risk, yes but 6x the return before tax considerations. I'm not sure what you mean "get to invest the mortgage payment". This is two scenarios using a one time $100K windfall. The numbers are similar for slow-drip investing/loan payments.

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If you pay off the mortgage in your 1st scenario, then you have 1k monthly cashflow increase to invest with.

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Yeah I see now. Here's the if you invest that $986 mortgage payment the scenario looks like this after 10 years:

Invest $100K @ 7.5% = $211,206 total after 10 yrs(including principle)
Pay off mortgage invest $988/mo = $175,948 total after 10 years

So the delta is $35,258. If you up the horizon to 20 years, the delta is $71K in favor of investing. That's a 3.55% better return than paying off.

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Still not looking at the whole picture because in one scenario you have a mortgage on your house and the other you have no debt. Have to look at a net worth perspective.

In addition I think your numbers are wrong on the 20 year horizon.

100k at 7.5% over 20 years - 446k
988 per month at 7.5% over 20 years - 547k

Pay one extra payment a year, reduce that 30 yr to 17 or so. Then invest the other money you would put towards the principal. Classic win-win compromise.

Ragoo said:

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I personally am moving #5 to the bottom.

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I did the math on a 529 that is eventually cashed in or we use for education expenses that you would normally pay out of pocket. Even with the penalties it is not much worse than typical non-retirement savings and if it used for education then it is quite a bit better. Of course, we are currently back on step 4 since we decided to build a new home. My opinion and order may change to move 5 below 7 once we get 4 done again.

dallasiteinsa02 said:

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Ragoo said:

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I personally am moving #5 to the bottom.

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I did the math on a 529 that is eventually cashed in or we use for education expenses that you would normally pay out of pocket. Even with the penalties it is not much worse than typical non-retirement savings and if it used for education then it is quite a bit better. Of course, we are currently back on step 4 since we decided to build a new home. My opinion and order may change to move 5 below 7 once we get 4 done again.

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my thought process is that I am going to take care of my retirement and planning for my life first. My kids are 10 months. In 10 years hopefully my retirement nest egg will be such that I feel comfortable saving for their college. if not, We will figure college out as that time approaches. I am not willing to save for their college though at the detriment of my own retirement.

Ragoo said:

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dallasiteinsa02 said:

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Ragoo said:

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I personally am moving #5 to the bottom.

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I did the math on a 529 that is eventually cashed in or we use for education expenses that you would normally pay out of pocket. Even with the penalties it is not much worse than typical non-retirement savings and if it used for education then it is quite a bit better. Of course, we are currently back on step 4 since we decided to build a new home. My opinion and order may change to move 5 below 7 once we get 4 done again.

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my thought process is that I am going to take care of my retirement and planning for my life first. My kids are 10 months. In 10 years hopefully my retirement nest egg will be such that I feel comfortable saving for their college. if not, We will figure college out as that time approaches. I am not willing to save for their college though at the detriment of my own retirement.

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Meh, I put $100 a month into a 529 for my kids.. One's a newborn and one is a toddler, so hopefully we'll have some decent gains in the next 16+ years. Their grandparents add about $50 each a month. You don't have to be the one to fund it but opening one can be helpful.

I don't feel like that small amount is a detriment to my retirement but I do max retirement out, so I'd always suggest maxing out first then adding to their education. (Put the oxygen mask on yourself before you help your kid).

School prices inflating like they are now (I read somewhere it might be as high as 7% a year), feel like it's easier to get a jump on it now.

If you use the 529 distributions for qualified education expenses then the distributions should be tax free, we get a small tax income tax deduction in the state we live in as well for contributing to one.