Does it make sense to overpay mortgage?

cremeegg

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Not in a world where interest rates have to stay low.
I accept that as you said there is a "(huge) volume of debt in the world post financial crisis" and that this means that interest rates may have to stay low. The debt could be inflated away and that would allow interest rates to rise, even real rates. However there seems to be little appetite for this among Central Banks anywhere.

However this does not justify your assumption that equity returns can break the connection with a low risk free rate.
 

Sarenco

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The interest saving is the key figure and that's consistent at circa €20k.
That is only true if you assume that the weighted average interest rate will be 3% over the 30 years.

Cremeegg is right - you are assuming in your model that the equity risk premium will be significantly higher than the ERP over the last 100 years. Many commentators actually expect the ERP to be materially lower going forward.
 

Gordon Gekko

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I've never once referred to the risk-free rate so how is the equity risk premium relevant?

Prospective mortgage rates in Ireland and the expected return from a diversified portfolio of global equities are what's being discussed.

The salient point is that even if we increase the 3% to (say) 4% and decrease the 6.5%, the pension contribition still wins.
 

Gordon Gekko

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30 year fixed rate mortgages are available at 3.5% in Europe (ABN AMRO, ING, etc)...what does that suggest to you re mortgage rates?
 

Sarenco

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I've never once referred to the risk-free rate so how is the equity risk premium relevant?
It's implicit in your assumptions.

For the sake of simplicity, let's assume that banks can borrow money at the risk-free rate ("T") and can lend money to home buyers at T+3%.

Over the last century, the equity risk premium has averaged around T+4%.

T happens to be (effectively) zero at the moment but that hasn't always been the case. Over the last century, T has averaged around 3% in nominal terms.

So if you are going to assume average nominal equity returns of 7%, that implies that T will average at 3% over the period (assuming the ERP is constant).

The salient point is that even if we increase the 3% to (say) 4% and decrease the 6.5%, the pension contribition still wins.
Actually, the pension contribution "wins" even in circumstances where the annualised return on the equity portfolio is somewhat less than the weighted average mortgage rate over the period because of the tax relief.

For example, 100 compounded @2% over 30 years comfortably beats 60 compounded @3% over the same period.
 

Sarenco

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30 year fixed rate mortgages are available at 3.5% in Europe (ABN AMRO, ING, etc)...what does that suggest to you re mortgage rates?
That these lenders expect rates to increase significantly over the next 30 years!

3.5% is roughly double the variable home loan rates offered by those lenders on the continent.
 

Gordon Gekko

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That these lenders expect rates to increase significantly over the next 30 years!

3.5% is roughly double the variable home loan rates offered by those lenders on the continent.
And conventional wisdom is that Irish rates will fall to European norms!
 

Gordon Gekko

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Actually, the pension contribution "wins" even in circumstances where the annualised return on the equity portfolio is somewhat less than the weighted average mortgage rate over the period because of the tax relief.

For example, 100 compounded @2% over 30 years comfortably beats 60 compounded @3% over the same period.
Doesn't that ignore the fact that the proceeds of the €100 are trapped in a pension structure, whereas the interest saving isn't?

Gross vs net basically.
 

Sarenco

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And conventional wisdom is that Irish rates will fall to European norms!
Average rates on all outstanding Irish mortgages are actually pretty much bang in line with the equivalent Eurozone figure. The difference is that the Irish bargain rates (low margin trackers) are no longer available.

Whatever about conventional wisdom, I don't think there is any prospect that rates on new Irish mortgages will fall to Eurozone average rates in my lifetime. Our default rates are simply too high.
 

Sarenco

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Doesn't that ignore the fact that the proceeds of the €100 are trapped in a pension structure, whereas the interest saving isn't?

Gross vs net basically.
Well, yes, pension contributions are made out of gross income whereas a mortgage payment obviously comes out of net income. Is that your point? I suspect I'm missing a subtlety in your post.
 

Gordon Gekko

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Well, yes, pension contributions are made out of gross income whereas a mortgage payment obviously comes out of net income. Is that your point? I suspect I'm missing a subtlety in your post.
No worries...the compounded return from the €100 is in the retirement structure, so there's income tax etc to get it out, whereas the accumulated interest saving is net of tax.
 

Gordon Gekko

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Average rates on all outstanding Irish mortgages are actually pretty much bang in line with the equivalent Eurozone figure. The difference is that the Irish bargain rates (low margin trackers) are no longer available.

Whatever about conventional wisdom, I don't think there is any prospect that rates on new Irish mortgages will fall to Eurozone average rates in my lifetime. Our default rates are simply too high.
Funny enough, I believe that in our lifetimes (assuming we're neither ill nor OAPs), it will be possible for an Irish person to borrow directly from European banks at the same rates as our fellow EU citizens.
 

galway_blow_in

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I accept that as you said there is a "(huge) volume of debt in the world post financial crisis" and that this means that interest rates may have to stay low. The debt could be inflated away and that would allow interest rates to rise, even real rates. However there seems to be little appetite for this among Central Banks anywhere.

However this does not justify your assumption that equity returns can break the connection with a low risk free rate.
surely low interest rates will drive people into riskier assets ?
 

Sarenco

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really ? , bar the u.s market , the rest of them barely moved since this time in 2007
You're joking right?

$10,000 invested in Vanguard's Global (Ex-US) Index Fund (VGTSX) on 1 January 2007 would have been worth $12,954 on 31 July 2017 (with all dividends reinvested). That's pretty remarkable given the 58.5% drawdown in 2008/2009.

Anyway, I think we are starting to drift away from the topic under discussion - whether it makes sense to prioritise pension contributions over more aggressively paying down a mortgage.
 

galway_blow_in

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You're joking right?

$10,000 invested in Vanguard's Global (Ex-US) Index Fund (VGTSX) on 1 January 2007 would have been worth $12,954 on 31 July 2017 (with all dividends reinvested). That's pretty remarkable given the 58.5% drawdown in 2008/2009.

Anyway, I think we are starting to drift away from the topic under discussion - whether it makes sense to prioritise pension contributions over more aggressively paying down a mortgage.
if you invested $10000 today , would you be content for it to be worth $12954 on september 1st 2027 ?

its less than 3% per annum ! , so what if there was a 50% drawdown in 2008 - 2009 , the DAX dropped by nearly a third from mid 2015 to early 2016 , european markets are more volatile than u.s ones , they veer in and out of plus 10% corrections on a regular basis
 
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