White Coat Face Off: Mortgaging Your Future?

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I’m in the midst of a bit of a call weekend beat down. Nothing terrible, just busy. Pacers, and consults, and pages, and so on.

But the show must go on. Early retirement waits for no one.

And it seems to me that today is as good a day to continue my pseudo-dialogue with the Whitecoat Investor as any.

This is the seventh installment in a series, in which I argue against all of his good reasons for foregoing early retirement.

But I’m actually not arguing against his reason number seven.

Reason number seven has to do with paying back med school debt and seems overly specific to  financial issues facing doctors. So (even though I disagree with his reasoning) I’ll skip that one.

Which for all of you math geniuses out there means that I’m moving on to issue number eight:

 

You’ll have less time to pay off a mortgage.

The early retiree won’t want a mortgage hanging over his head in retirement.  That means he’ll need to be more frugal in his choice of housing and he’ll need a more aggressive mortgage loan, such as a 15 year versus a more traditional 30 year.  It turns out you can live in a much nicer house if you’re willing to work an extra decade or two.

This argument is best broken down in pieces.

 

The early retiree won’t want a mortgage hanging over his head in retirement.

 

I don’t necessarily agree that “the early retiree won’t want a mortgage hanging over his head in retirement.”  Although this is certainly the case for me, you can make a pretty reasonable case for holding a large mortgage in retirement at a low interest-rate, as a hedge against inflation.  (Hat tip: Mr. Mark.)

The way that this scheme works is that you take out a “cash out” low interest rate mortgage secured by your own home when you retire and then you invest the cash in assets with a higher expected rate of return than your loan’s interest rate.

This accomplishes two things:

The first is that the loan itself is both the tax break and a hedge against inflation. If there is runaway inflation then you will end up paying your loan back at pennies on the dollar (Whereas you have invested with “real” dollars.)

This is important because to a retiree inflation is a real threat. (Your wages can’t go up because you’re not working .)

And the second thing is that this is a form of very cheap leverage. The money you take out against your home allows you to have a much lower cost of money compared to almost any other manner of borrowing to invest.

That being said I will admit that I’m psychologically uncomfortable with leverage and I would would prefer to simply pay off my mortgage prior to retirement.

 

That means he’ll need to be more frugal in his choice of housing

 

We’re getting to an important conflict of ideas here.

The working assumption of this statement seems to be that more expensive houses equate to more happiness.

For me at least, this was not the case.

We bought our dream home one year out of fellowship. And I love the house. It’s an 1890 Victorian with beautiful fir floors and tall ceilings and lots of sunlight in a terrific walkable urban neighborhood.

And it feels flattering when people come over to our house and are impressed by it. But it doesn’t really make me happy.

In fact I honestly believe that I’m no happier owning it than I would be renting a house half it’s size or less.

And this aspect of the pursuit of early retirement, I would argue, is one of it’s main features.

To one of us (mustachian types) not buying a McMansion is not a deprivation. It is a gluttonous and pleasurable purchase of our own freedom.

20140123-LITTEHOUSE-slide-Y5F5-jumboMy new dream house:  704 sq ft.  (Kids sleep in tents in the back yard.)

 

That means… he’ll need a more aggressive mortgage loan, such as a 15 year versus a more traditional 30 year.

 

The White Coat Investor kind of lost me here.

Before I ever got interested in early retirement I refinanced my house from a 30 year loan to a 15 year loan.

For me this was an obvious choice for multiple reasons.

  • I was able to lock in a ridiculously low interest rate.
  • By paying an extra 15 to 20% a month I could own my home in half the time.
  • It was a form of lifestyle inflation insurance. (In other words it was a forced savings plan.)

For these reasons, to me, it almost always makes sense to make your mortgage as short term as possible.

It turns out you can live in a much nicer house if you’re willing to work an extra decade or two.

Actually I completely agree with this sentiment. It’s just that I would phrase it in a slightly different way. I would say:

“It turns out that if you’re willing to live in a slightly less fancy house, you can be financially independent for many more years of your life.”

In both scenarios you will have a roof over your head and a warm place to sleep at night. You will have a stove to cook on, and a freezer to freeze things in. Indoor plumbing? Not a problem.

But it only one of these scenarios will you have time to do all of the things that you want to do. Like tending to your garden, and reading books, and exercising, and creating that which is meaningful to you simply because you think it is meaningful. You can even work if you want to. You just don’t have to.

So as always it comes down to a simple question of values.

What’s more important to you?

Armchairs or autonomy?

Crown moldings or creative freedom?

Square footage or spare time?

There’s no right answer, of course. But there is a choice to be made. (And the sooner we make it the better.)

 

If you want to catch up on other installments of this series, here are the links…

 

http://www.milesdividendmd.com/whitecoat-faceoff-unballing-your-yarn/

http://www.milesdividendmd.com/white-coat-faceoff-too-much-saving/

http://www.milesdividendmd.com/whit-coat-face-off-social-security/

http://www.milesdividendmd.com/white-coat-face-off-obamacare/

http://www.milesdividendmd.com/death-with-benefits/

 http://www.milesdividendmd.com/white-coat-face-off-playing-catch-up/

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4 Responses to “White Coat Face Off: Mortgaging Your Future?”

  1. Robert August 4, 2014 at 12:30 pm #

    Alexi, I’m in agreement on your points above, including reluctance to carry a large mortgage into retirement, especially if the purpose is to have money to invest in investments with a higher expected return (typically stocks). Particularly in light of our bonds vs. equities discussion, I’m sure you agree that it isn’t wise to use mortgage/home equity proceeds to buy stocks, unless it is money you can afford to lose (at least a large fraction of), especially if your time frame is relatively short.

    Another issue with that strategy, though, is that there are limits on tax-deductibility of cash-out refinancing. See IRS Pub 936 or talk to a tax specialist. My understanding is that if used for stocks, this would be considered a home equity loan and thus limited to $100,000 (if married, filing jointly) of loan for which interest would be deductible, and even that would disappear if subject to AMT. I’m not expert in this, so do your own homework, but I believe this is the situation.

  2. Miles Dividend M.D. August 4, 2014 at 5:19 pm #

    That’s a good point Robert. I haven’t seriously considered this angle because I am very leverage averse.

    If your understanding of the tax law is right, then it seems the move would be to sell your house, buy another with a mortgage, and invest the proceeds from the sale?

    It might be a good Idea if you happened to perform this maneuver at a time with low interest rights and high TIPS yields (like 2008.) That would be riskless arbitrage, but admittedly it is a rare scenario indeed.

    • Robert August 4, 2014 at 6:25 pm #

      That would work, in principle, since interest from mortgages used for ACQUISITION of a house is fully deductible, up to I believe $1.1 million or something like that. However, there is a lot of slippage on house transactions (realtor fees, inspections, closing costs, etc.) on both sides of that transaction, so I would hope that the person had a better reason to switch houses than just this cash extraction angle!
      I’d be surprised if you could get a mortgage for less than TIPS rates. Was that indeed the case in 2008? Of course, unless you had other sources of income, you’d need the TIPS to pay out monthly so you could pay the mortgage. Not sure how you’d structure that, but I guess some kind of ladder. But I doubt you could get that using TIPS (isn’t there a 5 year lock-up or something?)

      • Miles Dividend M.D. August 4, 2014 at 8:42 pm #

        Robert there’s no five-year lock up on the tips, you can always sell them on the secondary market.

        I believe you’re thinking of I bonds which are a very nice option in a taxable account, but you’re limited to only 10,000 dollars purchased per year.

        Check out the historical yield with tips.

        http://blogs.reuters.com/felix-salmon/2010/08/11/chart-of-the-day-tips-yields/

        I would happily buy a guaranteed real 4% yield with A loan borrowed at a nominal 4-5%. Short of deflation you will always win this bet. I would happily load up 80% of my tax-deferred space with such TIPS.

        it’s worth it to be aware of such a possibility so that the next time it happens you can pounce.

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