LTT's vs Mortgage

Discussion of the Bond portion of the Permanent Portfolio

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KevinW
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Re: LTT's vs Mortgage

Post by KevinW » Fri May 06, 2011 4:41 pm

IMO it's perfectly valid to reexamine prepaying a mortgage or other long-term debt vs investing.  I struggle with this myself.  However I think the decision should be debt vs 4x25 PP, not debt vs the bond part of the PP.

Interestingly, in "Inflation-Proofing Your Investments" I believe, HB suggested only using variable-rate mortgages.  The rationale was that fixed rate mortgages infuse an inappropriate level of interest rate speculation into what should be a simple consumer purchase.  Arbitraging interest rates should be a VP speculation, not part of putting shelter over your family's head.  Food for thought.
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Re: LTT's vs Mortgage

Post by MediumTex » Fri May 06, 2011 4:59 pm

KevinW wrote: Interestingly, in "Inflation-Proofing Your Investments" I believe, HB suggested only using variable-rate mortgages.  The rationale was that fixed rate mortgages infuse an inappropriate level of interest rate speculation into what should be a simple consumer purchase.  Arbitraging interest rates should be a VP speculation, not part of putting shelter over your family's head.  Food for thought.
I think Harry Browne might have reconsidered that advice if mortgage rates were in the 4-5% range rather than the 12%+ range they were in when he wrote that.

Also, I think it is easier to refinance today than it used to be.

The way I look at it, my fixed rate mortgage is ALSO a variable rate mortgage because if rates drop I can just refinance without much expense or hassle.

I don't think there is any good reason not to lock in today's rates on a mortgage if you can.  If they go lower, you can refinance, if they go higher, you will be happy.

If mortgage rates were 12% right now, however, I would probably be saying the same thing that Harry Browne was saying.

Just my opinion, of course.
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RickV42
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Re: LTT's vs Mortgage

Post by RickV42 » Fri May 06, 2011 6:10 pm

I analyzed this (similar question to mortgage pay down/buying bonds) for a long time and decided to pay down, then pay off a mortgage in 2009 on good 4-family I own which was mortgaged at 30 year for 5%.  It was an even harder decision as it is investment property and most would say to keep mortgage.  I so much wanted to add to the PP!

Considerations
1. You should have basic minimum level of cash (1 year or whatever your target) and pay down/off should not drain below your basic/emergency level.  Also assumed is you should make full contributions to tax deferred accounts to the max before any pay down/off.

2.  Paying down mortgage is RISK FREE RETURN – this is hugely underrated when getting fancy and comparing yields.  Mortgage interest rates should not be compared directly against risk assets (including bonds).  8% market return is better than 5% mortgage rate, but is 8% certain?  If there is only a 50% certainty, wouldn’t it really be 4% market vs. 5% mortgage rate?

3.  You get the interest deduction so keep the mortgage?  Well, you may not receive full deduction now -which many people don't know.  Later, you don't know what circumstances will bring as far as future income / tax position.  Also, there has been some talk about eliminating the property interest deduction, or phasing it out in the future, a risk to consider.  Another way to look at it, you eliminate your dependence on the government in making your decision work.

4. Illiquid. Again, assuming you have emergency/basic level of liquidity, if you pay off mortgage completely, chances are you can get at least partial liquidity out of it via home equity.  Yes bank can pull the line, but if you owe zero you can probably get something.  You don’t get charged interest for an unused HELOC.  If you really want full liquidity - sell the place and rent or buy smaller home or what have you.  In any case, you don’t buy a house for mortgage derived liquidity, and probably should be using it for investing/living cash anyway. 

5.  Asset protection.  For personal residences, depending on the state, homestead law can be taken advantage of to protect that portion of your assets.  There are tradeoffs of course, just not a point usually brought up in these discussions. 

6.  The reverse mortgage question.  If you could, would you take out a mortgage to put money into a PP or buy long term bonds (pick your asset) now?  Is the decision to pay off / pay down your mortgage any different just because you already have a mortgage?  Why?  I answered I would not take out a mortgage to buy more PP (bonds or whatever).  If you answer yes, why not keep going with this logic and get another mortgage or home equity loan (in theory). 

7.  If yes to #4.  is taking another mortgage out for .5% to 2% (or whatever) in theoretical gain worth it in terms of sleep at night factor?  I decided no because there are at times, months, maybe years where you worry due to the alternative asset price fluctuations.   

8.  Work involved constantly evaluating arbitrage as rates move around, both mortgage rates, and treasury rates.  In other words, do you plan to do this analysis every month, year?    Moving money around make you feel like you are doing something?  Do you see Bill Gross taking out loans to buy bonds?

9.  Debt is great in inflation.  What happens in deflation?  Inflation is not guaranteed.   

10.  I believe overall long term big picture risk is lower eliminating mortgage.  Lose your job, your investments, and you still have a place to live and/or your bills are lower.  Your worse case is not as bad when you have your mortgage paid off (again assuming basic savings established).    Leverage something else if you want to place bets.

11.  Housing is a consumption item.  Should you have loans on consumption items?    Shouldn’t the loan be eliminated as fast as possible?   

Best reading on subject I found, both pro and con:  http://www.early-retirement.org/forums/ ... .html  along with on Bogleheads.

Debt is debt, and investments should be from savings.

I found after paying off mortgage, it helps make things clearer.  I’m now wondering why I don’t sell the property and put all money into the PP.  With a mortgage, it was easy to rationalize taking money I that I owed somebody else and investing it somewhere else.
I wouldn’t argue strongly with anyone who does something else.
 
Anyone want to purchase a nice rental property?    I’ll give you some cash back with the deal to put in long term treasuries.  ;)
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Re: LTT's vs Mortgage

Post by HB Reader » Sun May 08, 2011 2:48 pm

RickV42 --

I very much agree, especially with #1 and #2.  Reasonable liquidity and the RISK FREE RETURN calculation should, in most cases, be the overriding considerations.  I also found that paying off my mortgage a few years back helped make other financial decisions much cleaner.

Financial services industry propaganda often makes having debt or a mortgage seem more sophisticated than being debt free.  Often (perhaps usually) the reverse is true.  A broker recently told my niece in Pennsylvania that paying off a mortgage (5.875% in her case, funded from her account at his firm) was "usually an emotional decision and not based on solid financial considerations."  I then calculated that given her federal and state tax rate, she would have to earn north of 7% on a Treasury security to breakeven in terms of return with comparable security, even with the mortgage income tax break factored in.  I hopes she asks him if he can find one. 
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