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 Post subject: Do you save or do you pay it down?
PostPosted: Thu Jan 10, 2013 11:06 pm 

Joined: Fri Dec 14, 2007 6:45 pm
Posts: 179
Just thinking about the future and wanted to throw it out there...

You just moved into a new house about 4 months ago. You have a 30 year mortgage at 3.625%. There are no plans to move anytime soon, but you can definitely see moving up in house in about 15 years or so.

Would you use extra money to pay down your mortgage or would you invest it to put towards that next house way down the road?

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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 1:29 am 

Joined: Tue Jun 30, 2009 9:44 pm
Posts: 275
Location: Atlanta, Georgia
You will hear both sides answer, but my vote is for investing it. Over 15 years, you should be able to get a better rate of return by investing than the 3.635% you'd save on the mortgage.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 2:39 am 

Joined: Wed Nov 07, 2012 6:21 am
Posts: 141
I definitely agree with LeRainDrop. Wisely investing your money will easily beat 3.625% over 15 years.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 5:06 am 

Joined: Thu Apr 05, 2007 3:05 pm
Posts: 1323
You could also do a hybrid approach, investing your "extra" money and putting your tax savings from the mortgage interest toward paying down the principal.

If you buy a house for $200K with 10% down, after 15 years you will have paid $82,222 in interest while gaining only $65,995 in equity. That's the downside of a 30-year mortgage. But your tax savings would be roughly $29,000. If you apply those tax savings toward your principal you'd have that much more equity to put toward your new home.

Or you could just invest it all. It depends in part on how motivated you are by seeing progress, and how that motivation affects your investing/savings rate. Personal finance is rarely governed by bottom-line considerations alone; we are not entirely rational beings when it comes to our finances, which is why financially irrational strategies like Dave Ramsey's "debt snowball" method can actually achieve better results with many people than the financially optimal approach.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 5:54 am 

Joined: Wed Nov 07, 2012 6:21 am
Posts: 141
Brad, the point of investing the money is to offset the interest caused by the mortgage. If you can make a higher interest than that caused by paying down the loan, then you are effectively throwing money away if you pay down the loan instead of invest the money.

The debt snowball approach works because it has an active amount of discipline involved. It is an unemotional, methodical way of paying down numerous bills. The reason why so many people fail at investing themselves is that they fail to invest in an unemotional, methodical manner.

Most investors are, when doing their own investments, quite emotional and unable to hang on to stocks when they see them going down. Multiple studies have shown that the inability of the average investor to stay unemotional contributes negatively to the value of their portfolio. Consistent discipline in investing (if done wisely) pays off. Many people were simply never taught how to be disciplined when investing.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 6:38 am 

Joined: Thu Apr 05, 2007 3:05 pm
Posts: 1323
I understand the argument from a pure financial perspective, I was just referring to the psychological part of the equation.

Under the debt snowball, people should lose more money to interest than they would if they paid off the highest-interest debt first. In cases where people are carrying huge debts the difference can amount to many thousands of dollars. And yet the snowball works for many people because of the motivational power that people feel by eliminating sources of debt: you get the smallest debts out of the way and consolidate so it doesn't feel so overwhelming.

A 30-year mortgage can feel overwhelming (I have relatives who nonchalantly say, "we'll never be able to pay off our house"), as can the prospect of having to save and invest many hundreds of thousands of dollars to fund one's own retirement. Some people view it as a challenge to meet; others view it as an insurmountable task and give up. I just think that it's important to know where you sit on that scale so you can evaluate realistically whether you will actually invest "extra" money or if you'll end up spending it. Many people start out with the best of intentions but lose motivation over time if they don't see tangible progress.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 7:02 am 

Joined: Thu Apr 05, 2007 3:05 pm
Posts: 1323
Just another thought on the non-financial front as well: much depends on how you feel about debt. For some people, debt feels like a constraining stone around their necks, and it's worth the investment opportunity cost to pay it down. It boils down to the question of how much you are willing to pay to be free of debt. For some, that freedom is practically priceless because it opens up many new opportunities (the chance to pursue a different career, to cut back on hours and spend more time with family, etc.), so it's worth foregoing millions in investment returns, even if those millions could hypothetically give you the same or even greater freedom. In part this is because debt is certain, whereas investment returns are not. You know for a fact that you'll be paying x% on your mortgage for 30 years, whereas you can't say for sure that your investments will do better: all you can say is that the probability is very high that they will.

In any case, the timeframe of debt payoff matters too; having that freedom earlier rather than later may be worth paying for. In each case there are costs and benefits, and I think it's a very personal decision.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 8:21 am 

Joined: Tue Mar 11, 2008 12:19 pm
Posts: 1716
Location: Ottawa, Canada
There is no hard-and-fast "right" answer. The right answer is "whichever one lets you sleep better."

There is, however, a "wrong" answer: Neither. As long as you're either investing extra cash or using it to pay down debt, you're getting ahead. Just don't waste it on "stuff."


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 8:51 am 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
Matthew Clinger wrote:
Brad, the point of investing the money is to offset the interest caused by the mortgage. If you can make a higher interest than that caused by paying down the loan, then you are effectively throwing money away if you pay down the loan instead of invest the money.


Our resident expert will certainly guarantee that if you invest the money, you will do better than 3.625% (+tax benefit if you itemize). If you pay him, I'm sure it comes with some fancy guarantee. I wish my magic 8 ball was that good. It is always just says, "call me maybe."

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Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 9:12 am 
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Joined: Wed Sep 23, 2009 9:01 am
Posts: 5303
I agree that there is no right answer. I also agree that emotional/psychological considerations have some value. But that's very hard to measure.

Personally there is no way I would pay any more than I was required to on a mortgage under 4% whether it is tax deductible or not. Instead, I would deposit any extra into a high quality, intermediate term, unleveraged bond fund. Such a fund might yield a little less than the mortgage right now but over the next 30 years the likelihood of underperforming the mortgage is slim. Plus, you can always use the lump sum to pay off the mortgage at any time if the emotions overcome you.

This is in fact exactly what I am doing with my own 30 year mortgage.

But you must be aware that doing this requires discipline. If you just try to do it haphazardly by putting away a little extra whenever you have it then it is likely to fail. Similarly, if you ever withdraw from that mortgage offset fund, even in an emergency, you'll be on the slipper slope to failure. (You should have a separate emergency fund.)

But if you can maintain the discipline to make extra payments to yourself consistently every month and if you can overcome any emotional considerations and understand what the math is telling you, it's a no-brainer.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 9:43 am 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
DoingHomework wrote:
I agree that there is no right answer. I also agree that emotional/psychological considerations have some value. But that's very hard to measure.

Personally there is no way I would pay any more than I was required to on a mortgage under 4% whether it is tax deductible or not. Instead, I would deposit any extra into a high quality, intermediate term, unleveraged bond fund. Such a fund might yield a little less than the mortgage right now but over the next 30 years the likelihood of underperforming the mortgage is slim. Plus, you can always use the lump sum to pay off the mortgage at any time if the emotions overcome you.

This is in fact exactly what I am doing with my own 30 year mortgage.

But you must be aware that doing this requires discipline. If you just try to do it haphazardly by putting away a little extra whenever you have it then it is likely to fail. Similarly, if you ever withdraw from that mortgage offset fund, even in an emergency, you'll be on the slipper slope to failure. (You should have a separate emergency fund.)

But if you can maintain the discipline to make extra payments to yourself consistently every month and if you can overcome any emotional considerations and understand what the math is telling you, it's a no-brainer.


As someone pointed out upthread, it also isn't either/or. I pay the minimum on mortgage as well.

You can also take more risk if you have significantly more capital than the mortgage. E.g., say your mortgage balance was $100k and you have $1MM in investable assets with liquidity. I wouldn't just set aside $100k in a bond fund and then apply my AA to the other $900k. I just play it out and let the cards fall where they may. This is also why I only keep 2-3 months of expenses in cash (ibonds and CD's actually), as I have a broader portfolio I can always tap.

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Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 10:17 am 
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Joined: Wed Sep 23, 2009 9:01 am
Posts: 5303
Bichon Frise wrote:
As someone pointed out upthread, it also isn't either/or. I pay the minimum on mortgage as well.

You can also take more risk if you have significantly more capital than the mortgage. E.g., say your mortgage balance was $100k and you have $1MM in investable assets with liquidity. I wouldn't just set aside $100k in a bond fund and then apply my AA to the other $900k. I just play it out and let the cards fall where they may. This is also why I only keep 2-3 months of expenses in cash (ibonds and CD's actually), as I have a broader portfolio I can always tap.


Right, I agree with you. In my case I confess that there is a part of me that, emotionally and irrationally, likes seeing a separate offset account and watching the difference between that account balance and the mortgage balance shrink.

I also plan to use this account to actually pay the mortgage payments from when I retire in a couple of years so segregation makes sense to me for that reason as well.

But at the same time, when I compute my asset allocation I lump everything together including that account. I also take a little bit of risk in the offset account. I have it in corporate bonds rather than a risk free investment and I am comfortable with a duration of around 5 years even in this environment.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 3:40 pm 

Joined: Wed Nov 07, 2012 6:21 am
Posts: 141
Bichon Frise wrote:
Our resident expert will certainly guarantee that if you invest the money, you will do better than 3.625% (+tax benefit if you itemize). If you pay him, I'm sure it comes with some fancy guarantee. I wish my magic 8 ball was that good. It is always just says, "call me maybe."


Granted that results in the short-term are not guarranteed, but in "What Works on Wall Street" (Fourth Edition), it shows that over 10-year periods of time, the return on investing merely in the top 10% of stocks in regards to having a low P/E ratio would return a minimum of 6.07% over 10 years (Years covered 1964-2009). And considering that this was tested month-by-month, this means that 433 results were collected and this was the absolute worst 10-year period out of 433 results.

And considering that multi-factor models are more profitable, indeed my system should create better returns than this. Even with buying and selling expenses, 6.07% will still beat the mortgage interest rate so long as the investment sizes aren't ridiculously small.

And my standards are much higher than merely looking at the top decile like it has in the book. Less than 2% (and sometimes less than 1%) of stocks make it through my screening process at any given time. Please recall that VTI is getting creamed by my stock portfolio in the "Stock Portfolio" thread. Considering that the gap is a mere 2.74% as of the last post and that the back-tested strategies on my forum that are older than 6 months are beating their comparisons by 7% or more, I expect the gap to widen even more in the future.


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 4:08 pm 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
Matthew Clinger wrote:
Bichon Frise wrote:
Our resident expert will certainly guarantee that if you invest the money, you will do better than 3.625% (+tax benefit if you itemize). If you pay him, I'm sure it comes with some fancy guarantee. I wish my magic 8 ball was that good. It is always just says, "call me maybe."


Granted that results in the short-term are not guarranteed, but in "What Works on Wall Street" (Fourth Edition), it shows that over 10-year periods of time, the return on investing merely in the top 10% of stocks in regards to having a low P/E ratio would return a minimum of 6.07% over 10 years (Years covered 1964-2009). And considering that this was tested month-by-month, this means that 433 results were collected and this was the absolute worst 10-year period out of 433 results.

And considering that multi-factor models are more profitable, indeed my system should create better returns than this. Even with buying and selling expenses, 6.07% will still beat the mortgage interest rate so long as the investment sizes aren't ridiculously small.

And my standards are much higher than merely looking at the top decile like it has in the book. Less than 2% (and sometimes less than 1%) of stocks make it through my screening process at any given time. Please recall that VTI is getting creamed by my stock portfolio in the "Stock Portfolio" thread. Considering that the gap is a mere 2.74% as of the last post and that the back-tested strategies on my forum that are older than 6 months are beating their comparisons by 7% or more, I expect the gap to widen even more in the future.


If only you had any money to put where your mouth is.

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Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: Do you save or do you pay it down?
PostPosted: Fri Jan 11, 2013 4:50 pm 

Joined: Wed Nov 07, 2012 6:21 am
Posts: 141
http://www.gambling-law-us.com/State-Law-Summary/

According to this site, it shows that social gambling is allowed in my state. Is it in yours? So although it isn't much, how about we make a bet? I'll bet you $20 that the spread between my stock strategy and VTI is 5% or more at 6-months. Granted my portfolio is already 2.74% ahead as of the last update, so I only have to make another 2.26% over 4 months. However, if the trend reverses or it simply doesn't advance enough, you win. I know that the 5% spread is rather conservative from my perspective, but then.. You don't really believe in my stock picking abilities, so that shouldn't bother you. And you did ask for money to be involved. So how about it?


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