[petsetc]

Been on TOTV almost 7 years and have read numerous threads on bonds and mortgages without comment. Now I would like to offer my thoughts based on numbers. If you are a believer in “Debt-Free” (as is my wife), this post may not be for you.

Main reasons people give for and against paying off the bonds include;

Pro – Debt-free, high interest rate, can recoup if you sell…

Con- May adversely affect future resale price, can’t be recouped if you sell, you have the
money available…

I have not seen anyone attempt a cash flow analysis, so that is my approach using my own bond number in CDD10 – Unit204 with an interest rate of 5.993%

CCD10 Unit 204 5.992%
..............Principal.....Interest.......Admin.. ...Total...........Balance.....Tax Discount 4% *
2020.............................................. ....................................20,806.43
2021.......417.30.......1,211.15.....111.35....1,7 39.79.......20,389.14........69.59
2022.......439.00.......1,189.21.....111.35....1,7 39.53.......19,950.14........69.58
2023.......462.37.......1,166.11.....111.35....1,7 39.82.......19,487.77........69.59
* Assumes you pay in November and take advantage of the 4% discount.

Looking specifically at 2022, the “cost” is $1,230.98 (interest + admin - discount)

My thoughts are, you put the balance in a S&P500 fund or a Total US Equity Fund and take a “safe withdrawal” of 4%** or $798.01 for a net negative flow of ($432.97) and you still have about $20K available should you suddenly need it.
In additional, the remaining balance is in the market growing at 8% (historical rate). If you use a more aggressive withdrawal rate the numbers improve (I use 5%).

** The bond payment is fixed whereas the "safe withdrawal rate" is adjusted for inflation in future years)


Looking at a new house, I arbitrarily chose CCD13 Unit 52V with an interest rate of 3.670%

CDD13 Unit 52V 3.670%
..............Principal.....Interest.......Admin.. ...Total...........Balance.....Tax Discount 4% *
2020.............................................. ................................... 31,276.03
2021.......629.89......1,072.78......120.32....1,8 22.99......30,646.14..........72.92
2022.......645.51......1,056.04......120.24....1,8 21.79......30,000.63..........72.87
2023.......662.86......1,038.86......120.25....1,8 21.97......29,337.77..........72.88
* Assumes you pay in November and take advantage of the 4% discount.

Again, using the same analysis,

Looking specifically at 2022, the “cost” is $1,103.41 (interest + admin - discount)

You put the balance in a S&P500 fund or a Total US Equity Fund and take a “safe withdrawal” of 4%** take $1,200. for a net POSITIVE cash flow of $96.59 and you still have about $30K available should you suddenly need it. In additional, the remaining balance is in the market growing at 8% (historical rate). If you use a more aggressive withdrawal rate the numbers improve.

It appears the “sweet spot” for the bonds is about 4%.


My final thought, do not pay off the bond because you don’t spend or bank "interest rates", you spend or bank cash.

---------------------------------------------------------------------------------------------------------------------

Mortgages Too !!!

I would contend the exact same reasoning applies to a mortgage. For simplicity, assume a loan to value of less than 80% to eliminate PMI and an escrow account.

The current 30 years fixed is about 3.2%, about 3.3% on a refinance.

Assume closing costs of $1,500 per $100K rolled back into the loan and no money out.

Loan amount $101,500. Interest Rate 3.3%
Monthly payment $439. Or $5,268 per year.
Principal paid down in first year $2,040.

$100,000 in an S&P500 or Total Market Fund
Safe Withdrawal Rate 4%** or $4,000 in year 1 for a net positive flow of $722.

Result – immediate positive cash flow with immediate access to the entire $100K

My final conclusion, my retirement is not about being debt-free, it’s about being able to live well with a solid cash strategy. I know this is not for everyone, but I do believe you have to “run-the-numbers” to be able to make an informed decision and this has been my attempt to help.

[manaboutown]

Great analysis!

A further consideration for me would be the income tax factor. Interest paid on bond is not tax deductible whereas mortgage interest usually has been tax deductible for most folks. Now that has changed in my case as I no longer itemize deductions. Dividends and realized gains, if any, in mutual funds are taxable whereas appreciation is not until it is realized.

One more thought. We have experienced a nine year long bull market, the longest ever. Will we see an 8% average gain per year over the next 10 to 20 years?

[petsetc]

Originally Posted by manaboutown

Great analysis!

A further consideration for me would be the income tax factor. Interest paid on bond is not tax deductible whereas mortgage interest usually has been tax deductible for most folks. Now that has changed in my case as I no longer itemize deductions. Dividends and realized gains, if any, in mutual funds are taxable whereas appreciation is not until it is realized.

One more thought. We have experienced a nine year long bull market, the longest ever. Will we see an 8% average gain per year over the next 10 to 20 years?

Agreed except I would content that you could make a strong argument that the bond interest and the fire tax are legitimate deductions since generally, this "expense" are included elsewhere. I believe the code says that non-ad valorem items are "normally" not deductible. So the two questions are, will I loose if audited? and will anyone even look at the dollars involved and care?

As for will we continue to see a historical 8%, I believe in the long run we will see continued growth, but for me, the year 1 analysis and the continued access to the principal is enough.

[Neils]

87,000 new IRS agents will be pointed straight at Red state taxpayers