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Post by archer on Dec 15, 2023 22:42:50 GMT
Maybe it's just me having been in the dark forever, but I have always thought it much better to pay out of pocket rather than take loans. Of course I did have a mortgage, (paid off early though). Smaller purchases like cars, I always paid up front, or sometimes took loans through the dealer with a cash incentive, and then just paid off the loan immediately. That said, I did see how in these recent years of really low interest rates (before 2022) and long term gains in the stock market it might make sense but this has been an extreme case of low rates and high earnings.
So, today I was using online calculators to compare the opportunity loss of paying up front vs loans. What I found was that for the total cost to be equal, the loan % has to be about 2X the return on investments, eg. a 5 year loan at 10% cost the same as paying lump sum at 5% earned on investments. I guess this makes sense because money invested earns compound interest, while loan interest is paid on a declining remaining principal.
I still feel averse to debt just on principle and am a little dismayed at how the above discourages saving, but I guess that's none of my business really if people want to borrow. I probably will borrow for major purchases in future and look at my debts as investments.
Just wanted to share this in case there is something I am missing in the consequences of paying up front vs taking loans.
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Post by liftlock on Dec 16, 2023 2:05:00 GMT
Maybe it's just me having been in the dark forever, but I have always thought it much better to pay out of pocket rather than take loans. Of course I did have a mortgage, (paid off early though). Smaller purchases like cars, I always paid up front, or sometimes took loans through the dealer with a cash incentive, and then just paid off the loan immediately. That said, I did see how in these recent years of really low interest rates (before 2022) and long term gains in the stock market it might make sense but this has been an extreme case of low rates and high earnings. So, today I was using online calculators to compare the opportunity loss of paying up front vs loans. What I found was that for the total cost to be equal, the loan % has to be about 2X the return on investments, eg. a 5 year loan at 10% cost the same as paying lump sum at 5% earned on investments. I guess this makes sense because money invested earns compound interest, while loan interest is paid on a declining remaining principal. I still feel averse to debt just on principle and am a little dismayed at how the above discourages saving, but I guess that's none of my business really if people want to borrow. I probably will borrow for major purchases in future and look at my debts as investments. Just wanted to share this in case there is something I am missing in the consequences of paying up front vs taking loans. I imagine there are a boatload of folks who are delighted to have long term mortgages at rates of 3% or less. |
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Post by retiredat48 on Dec 16, 2023 4:21:47 GMT
archer,...I am in the camp in favor of debt, if the circumstances warrant. I have held HELOCs for several decades, rolling over principal, with sums invested in my portfolio funds. Typically prime minus 3/4% rate HELOC. Over three decades, this heloc rate was usually LESS than typical mortgage rates. Until recently. The recent rollover/refinance offers were not favorable. I then converted the paydown period (typically ten more years) and was able to negotiate and get a 3% fixed rate for 17 years. I will likely keep these helocs until I die...never paying it off early. Why is it OK for a twentysomething to be able to buy a house, borrowing with about 80% borrowed, a highly leveraged situation compared to pay, with unsteady employment risk. We couch it and call it a "mortgage". But when a retiree does same, owns home 100%, but borrows a little, converting home equity to stock fund (or bond) equity, we cry wolf!! Go figure... R48
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Post by Mustang on Dec 16, 2023 8:11:41 GMT
Retirement is so much easier without debt. Pensions, social security, RMDs cover necessary expenses easier without the additional burden of debt servicing. I retired the same year we paid off our mortgage.
Incurring debt is a cash flow decision. Borrowing to make an investment is a calculated risk with the expectation that cash inflow from the investment will pay the cash outflow of debt servicing. The risk is if the investment performs poorly the debt remains.
Its a cash flow decision for the young buying a house as well. One of the necessities in life is shelter. Alternatives are usually rent or buy. The money spent on rent is pure consumption. At the end of the lease there is nothing to show for it. Buying a house with a mortgage is investing in an asset. The individual has approximately the same cash outflow but in the end owns a valuable asset.
Debt for consumption is completely different especially if it is credit card debt with high interest rates.
P.S. I knew a guy back in 1987 who on Black Monday mortgaged his house and put everything into the stock market. With the panic surrounding the stock market that day I couldn't have done it. But he did.
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Post by yogibearbull on Dec 16, 2023 12:07:22 GMT
Considering time value of money, an investment at 5% and loan at 10% are just that - loan is much more expensive than the investment. Mortgage loans, personal loans and most installment loans work like that - one pays the nominal rate on the remaining balance. Just adding up the interest payments and saying that cuts loan rate in half isn't correct.
There are also loans that charge the entire interest upfront. If one prepays, some of that interest may not be refunded.
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Post by retiredat48 on Dec 16, 2023 16:47:23 GMT
archer,...posted "What I found was that for the total cost to be equal, the loan % has to be about 2X the return on investments, eg. a 5 year loan at 10% cost the same as paying lump sum at 5% earned on investments." This example is difficult for me and perhaps others to deal with. You are stating a truism (I think)...that at the same rate, an investment is compounding upwards; the loan is often a continuous payment and sometimes a declining one. So the investment wins, barring defaults. I never borrowed and invested with the investment returns expected to be only half my loan rate. Usually I had investment rates ABOVE/HIGHER than the loan rate! Like my 3% fixed helocs today; I have treasuries at much higher rates available. R48
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Post by retiredat48 on Dec 16, 2023 16:59:50 GMT
Retirement is so much easier without debt. Pensions, social security, RMDs cover necessary expenses easier without the additional burden of debt servicing. I retired the same year we paid off our mortgage. Incurring debt is a cash flow decision. Borrowing to make an investment is a calculated risk with the expectation that cash inflow from the investment will pay the cash outflow of debt servicing. The risk is if the investment performs poorly the debt remains. Its a cash flow decision for the young buying a house as well. One of the necessities in life is shelter. Alternatives are usually rent or buy. The money spent on rent is pure consumption. At the end of the lease there is nothing to show for it. Buying a house with a mortgage is investing in an asset. The individual has approximately the same cash outflow but in the end owns a valuable asset. Debt for consumption is completely different especially if it is credit card debt with high interest rates. P.S. I knew a guy back in 1987 who on Black Monday mortgaged his house and put everything into the stock market. With the panic surrounding the stock market that day I couldn't have done it. But he did. ,...I understand your post. And for some they just can't live with any debt. There is a "behavior" aspect to this. But does there not come a time when opportunity recognized must be seized? And that may involve borrowed money. Such as: Many people now have mortgages at 3% rates. Some have posted they double pay every month, to draw down their mortgage faster. Now, is this really sound financial action in todays world of 7-8% mortgages and MM funds at 5%; "safe" treasuries available for 10 years at 4+%. Like they say, even taxi drivers know the value of long term 3% mortgages and they are not moving from their homes. Too bad janet Yellen blew it and did not refinance US Treasury debt long term when rates of 1.5% were available. I hear half of us treasury debt is short term and has to be rolled over within 3 years. So the question for mustang and others is: What is so magical about approaching or into retirement time that one has to get rid of 3% mortgages? Should people double down pay their mortgages off? The answer is clearly NO. Take that extra monthly mortgage payment and invest it. BTW a mortgage or heloc is a debt. And if you get to really hard times, and cannot pay next months mortgage, the banks don't care...you are in default. Without making double payments and saving the difference, one has savings to now use to continue monthly bank payments. So keeping the loan is actually "safer." R48 |
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Post by archer on Dec 16, 2023 17:59:25 GMT
archer ,...posted "What I found was that for the total cost to be equal, the loan % has to be about 2X the return on investments, eg. a 5 year loan at 10% cost the same as paying lump sum at 5% earned on investments." This example is difficult for me and perhaps others to deal with. You are stating a truism (I think)...that at the same rate, an investment is compounding upwards; the loan is often a continuous payment and sometimes a declining one. So the investment wins, barring defaults. I never borrowed and invested with the investment returns expected to be only half my loan rate. Usually I had investment rates ABOVE/HIGHER than the loan rate! Like my 3% fixed helocs today; I have treasuries at much higher rates available. R48 It might help if shared some context and a real example from running the numbers on lump sum purchases vs taking a loan. Without digging back through my search history to find the online calculators I used, I will approximate. According to the calculator as I remember, I can take a 10% 5 yr loan on a $40K car purchase and the total paid will come to ~$51K. If my investment accounts are earning even only 5%, $40K will grow to ~51K in that same 5 yr period. This is just an example to compare interest rates between the 2 strategies. In real life, the car loan currently averages only 6% resulting in a total expenditure of $46,400. I am comparing this to paying the $40K lump sum which would result in an opportunity loss of growing to $51K which wins by $4600. The 5% investment growth to $51K isn't guaranteed, but is considered a safe average for a 60/40 PF. Also, the taxes on a $40K lump sum withdrawal might be greater than making payments over time, depending on ones tax situation. As for other uses of borrowing, other factors must be considered. Real estate is usually an appreciating investment, and for ones home, as was pointed out, there are really only 2 options, and you do have to live somewhere. To borrow solely to invest is more of a gamble and doesn't involve something one needs to have. I would be less inclined to go that route. I can do that with leveraged funds instead. A car is a depreciating asset, so a case can be made not to dump all ones money in up front, especially given the rate of depreciation. There is another element I have not included which is in favor of paying lump sum. Inflation can offset the advantages of paying later vs now. |
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Post by retiredat48 on Dec 16, 2023 18:02:34 GMT
archer,...fair enough. I like your post.
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Post by Mustang on Dec 16, 2023 22:37:27 GMT
Mustang ,...I understand your post. And for some they just can't live with any debt. There is a "behavior" aspect to this. But does there not come a time when opportunity recognized must be seized? And that may involve borrowed money. Such as: Many people now have mortgages at 3% rates. Some have posted they double pay every month, to draw down their mortgage faster. Now, is this really sound financial action in todays world of 7-8% mortgages and MM funds at 5%; "safe" treasuries available for 10 years at 4+%. Like they say, even taxi drivers know the value of long term 3% mortgages and they are not moving from their homes. Too bad janet Yellen blew it and did not refinance US Treasury debt long term when rates of 1.5% were available. I hear half of us treasury debt is short term and has to be rolled over within 3 years. So the question for mustang and others is: What is so magical about approaching or into retirement time that one has to get rid of 3% mortgages? Should people double down pay their mortgages off? The answer is clearly NO. Take that extra monthly mortgage payment and invest it. BTW a mortgage or heloc is a debt. And if you get to really hard times, and cannot pay next months mortgage, the banks don't care...you are in default. Without making double payments and saving the difference, one has savings to now use to continue monthly bank payments. So keeping the loan is actually "safer." R48
Is the 3% mortgage fixed rate or variable rate. Variable rate mortgages are one of the things that is hurting people. If they budgeted house payments at 3% and are now making payments at 8-9% something else had to give. Low fixed rate mortgages are one of the reasons for an intro level housing shortage. Those with them are not willing to move and lock in a higher rate mortgage. If I bought a house with a fixed 3% mortgage I wouldn't give that up either.
I was looking at a chart of historic mortgage interest rates. They were 3% for a very short period of time, maybe 18 months, and during that time savings accounts and money market fund were basically paying nothing. So, under those circumstances I would not borrow at 3% and invest at zero. And now that Money Markets are paying 4% mortgages are 8-9%. money.usnews.com/loans/mortgages/articles/historical-mortgage-rates
I didn't understand this comment, " BTW a mortgage or heloc is a debt." Who thinks they aren't?
It seems that heloc have basically the same interest rate as regular mortgages. So, if an investor took a 3% heloc he must have done that between July 2020 and December 2021. It typically would have been a variable rate loan. The conversion to a fixed rate loan would have had to happen fairly quick be cause after than the rates started rising fast.
If I read your post correctly it was at a variable rate but you rolled it over into fixed at 3%. And, the treasury notes are paying well above that. That is very good timing. But not what would be offered to most of us now. So, to answer your question no. I wouldn't do it today.
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Post by Deleted on Dec 16, 2023 23:48:57 GMT
I agree with R48. Actually learned it from him and few others on this forum. I have 30 year fixed at 2.75%, Money market is paying me 5%. Why would I pay extra towards my loan?
Every one in my neighborhood and friends who have mortgage refinanced to fixed when rates were less than 3%
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Post by Mustang on Dec 17, 2023 0:32:04 GMT
I agree with R48. Actually learned it from him and few others on this forum. I have 30 year fixed at 2.75%, Money market is paying me 5%. Why would I pay extra towards my loan? Every one in my neighborhood and friends who have mortgage refinanced to fixed when rates were less than 3% You wouldn't. Not when the cash flow from the money market is greater than your mortgage payment. When you refinanced weren't you refinancing for a lower rate? I once refinanced a house twice in two years because rates were dropping so fast.
Note knowing the specifics this is how I would have done it. I'd have refinanced to get a lower rate and lower house payments when rates were 3%. Since rates are interrelated money markets would have been paying nothing at the time but that wouldn't matter. The goal would have been lower mortgage payments. Shortly after refinancing the Fed started cranking up rates. Money market rates quickly went to 4-5%.
But, I wouldn't have known ahead of time that the Fed would crank up rates and rates are interrelated. Loan rates and money market rate move up and down together. After the Fed cranked up rates, home mortgages and home equity loans were no longer be 3%. That opportunity has passed. I would not borrow at 8% to invest in a money market that pays 5% or treasuries that pay 4%.
I had mentioned before it was a cash flow decision. If the investment more than pays for the loan then its a calculated risk.
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Post by keppelbay on Dec 17, 2023 2:12:11 GMT
retiredat48, I'm curious - is the interest on your HELOC tax deductable? If not, you'd probably have to move out on the risk spectrum to get enough spread to make this worthwhile. There's not a lot left after tax on a safe 5% yield (treasury/agency/MM) vs the 3% cost of money.
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Post by retiredat48 on Dec 17, 2023 15:16:57 GMT
I agree with R48. Actually learned it from him and few others on this forum. I have 30 year fixed at 2.75%, Money market is paying me 5%. Why would I pay extra towards my loan? Every one in my neighborhood and friends who have mortgage refinanced to fixed when rates were less than 3% Very good waffle! To all...When I have posted about borrowing as an investing tool, I have stated : "When the opportunity rises..." Of course we did not always have 3% mortgages. But an 18 month period is a long time to realize the benefit. I didn't always have 3% fixed HELOC lasting 18 years! But have carried HELOCs in the past because in my experience with loans I would get at Prime minus 3/4%, and were always below mortgage rate going forward (until recently), and often represented a rate amount less than the stock market general returns. I also backed up the truck and accepted OCCASIONAL credit card low rate/low fee loans. Some were 0% rate, 0% fee, for a year. I don't question the banks on this; got such loans, typically 0% for a one, or two and lately 3% fee. Got an offer recently for 3% fee, 0%, 10 months. Not that attractive anymore. I also lived on such low rate HELOCs during my sixties, keeping income low, and converting Trad to ROTH IRA each year. Didn't have roths when I worked; now I have a large ROTH. Low rate borrowed money to save large rate taxes, and to keep money working in my portfolio. That is the key, to keep more money invested. I didn't have to withdraw from my IRAs to live on--a feature of me retiring early. I did not settle for simple arbitrage such as borrow lower and put in higher yield junk bond fund. While that was available, I wanted stock market exposure, and got it. (Money is fungible, and I owned junk bond funds as well.) I have posted often I think young investors should borrow if rates are good, to fund 401.Ks where the company is making a 50% to 100% match... If you are skipping any year. A year lost in 401.K or IRA funding is a year lost forever. The 401.K with 50% match will likely always stay ahead in value versus your loan payments...for a long time. And this invested money compounds upward...tax free! Perhaps some more "ah ha" moments here for some readers. R48 |
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Post by retiredat48 on Dec 17, 2023 15:29:20 GMT
retiredat48 , I'm curious - is the interest on your HELOC tax deductable? If not, you'd probably have to move out on the risk spectrum to get enough spread to make this worthwhile. There's not a lot left after tax on a safe 5% yield (treasury/agency/MM) vs the 3% cost of money. Yes, the interest is tax deductible. A decade or so there were questions re this, but gvt seems to have ceded this. My banks actually label it "mortgage interest" even though it is helocs. Re 5% MM yields, see post above. I used the monies for fixed income or market investments that I considered would return more. Albeit I think a safe gvt bond at 5%, subtracting the loan at 3% plus a little, is monetarily a plus and worth it. So keppelbay , for the more adventurous such as you, how about that PAXS PIMCO Income CEF, at 12.81% yield, priced at a minus 4% discount, (Leveraged) structured fund, that is now net earning 100% of its monthly dividend? Hmmm. We've already had the massive rate adjustment from ZIRP to 5+% rates. Edit to add. So with PAXS, you borrow $10,000 at 3%, costing you a little more than $300 a year as loan is paid monthly; PAXS pays monthly...$1281 total at year end. You pocket the difference. Yes, you let principal ride. BTW My loan positions can be quickly shut down if things become unfavorable. But I plan to take the 3% fixed HELOC with me to my deathbed. R48 R48 |
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Post by archer on Dec 17, 2023 22:12:59 GMT
Here is a link to the loan calculator I used. I only used the one at the top, and then used a compound interest calculator to compare investment growth. I suppose the first calculator page would provide both the total paid on a loan and also on that same page the 2nd calculator for deferring the loan payment would essentially be the same thing as using the compound interest calculator. The results came out about the same. That being whatever the interest is on the loan, you save about 50% paying off all at once, or pay the same total if the interest rate were 1/2. This again is to make a point of comparing total paid making monthly loan payments at X interest rate vs that same loan principal amount invested at 1/2X rate. So in the case of retiredat48, example of PAXS: Borrow $10K at 3% on a 10 year you pay $1587 in interest. Immediately put that $10K into PAXS paying 12.81% and in 10 yrs you earn $70,041 <$1587> +/- whatever the price difference is with PAXS in 10 yrs. and whatever the tax consequences are, which I don't want to go into as it will vary for everyone.
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Post by archer on Dec 18, 2023 0:44:43 GMT
That's quite a leap of faith that PAXS will pay 12.81% for 10 years. Sign me up! Will the price go up and down or just up? Will it even exist in 10 years? As with many things we can only plan based on what we know to be the case now, and then decide on the risk of the unknown. For spreading out risk, one can diversify into other yielders like people often do with individual bond holdings. Before borrowing to invest in CEFs or other holdings I would want to look into it more. Like, how many funds has Pimco managed that disappeared leaving investors without. They have discontinued funds but merged them with other funds leaving investors whole. My main concern with CEFs is the number of them that have lost NAV and price over the years. Ultimately I am only interested in total return after all shenanigans to get there. |
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Post by steelpony10 on Dec 18, 2023 2:09:53 GMT
archer , Well using PAXS for example, in 6-7 years (72/10-12%) you’d have all your investment back, reinvested or squirreled away somewhere else. All I saw with a balanced approach iwas decreased shares along with maybe reduced cap gains and decreasing income at times. Taking the quicker income solution during the bank crisis we’ve received about 80% of our investment back by now over 14 years while developing a large “balanced” position in VTI as a backup. If or when I cash anything will be the only time values become real. I don’t understand diversification especially with an equity position that covers all the U.S. equity market, 14 CEF’s with about 5k holdings professionally managed and a large 40+ year muni fund with 100’s of position when everything tanks to a different degree each market swoon because investors especially amateurs panic. Taxable 5% interest won’t last forever then what? The only thing I know about the future is cap gains and income will vary. Even though all investments have flaws it’s not all bad news all the time. I thought my risk was running out of money not everywhere I look.
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Post by keppelbay on Dec 18, 2023 6:06:22 GMT
So keppelbay , for the more adventurous such as you, how about that PAXS PIMCO Income CEF, at 12.81% yield, priced at a minus 4% discount, (Leveraged) structured fund, that is now net earning 100% of its monthly dividend? Hmmm. We've already had the massive rate adjustment from ZIRP to 5+% rates. Edit to add. So with PAXS, you borrow $10,000 at 3%, costing you a little more than $300 a year as loan is paid monthly; PAXS pays monthly...$1281 total at year end. You pocket the difference. Yes, you let principal ride. R48 For many years, I was able to borrow at <2%, using a series of short term loans taken against assets (floating rate, libor based). I used the funds to buy a PIMIX equivalent, capturing about 3% spread. I used the income (plus other excess cashflow) to pay down the loans month by month, so the spread improved over time. I thought risk/reward was OK for an investment that was unlikely to lose significant value until rates started to climb. There was lots of time to plan an orderly exit from the loan before it ate up the spread in 2022. Overall, it worked well. (I don't live in the US, so the loan products available and the tax considerations are different).
(added by edit: I don't recall whether I directly borrowed to add to my PDI position back in 2015, or if I used excess income to buy it instead of paying down the loan. Amounts to the same thing.)
Given what I would have to pay now for a similar loan, there is no spread on the lower-risk assets. I'm starting to gain confidence that the bottom is in for the PIMCO CEFs (and others like WDI), so I have been adding to my positions in these with excess income. But, I'm not sure if I'm ready to use leverage to buy a volatile leveraged product. On one hand: no guts, no glory. On the other: how much 'excess' income do I need? I'm already steadily growing the income stream.
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Post by retiredat48 on Dec 18, 2023 15:06:22 GMT
keppelbay,...Yes on reply. BTW I have followed you for years. K is good reference for CEFs and fixed income, folks. R48
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