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While trying to build a model for our finances, I've managed to confuse myself reading various threads. Any advice appreciated to get me on the right track or pointed towards modelling spreadsheets.

First Question:

While there are plenty of threads referencing paying off debt if I can't make a return higher than the mortgage rate - does that hold up over 30 years of inflation?

Second Question:

Is it correct that even passive-index tracker investments have taxable events which would lower the overall return versus paying down the debt? For example, Vanguard is north of 7% since inception - 7% compounded over 30 years would be higher than the debt payment and inflation.

Third Question:

If we're already in one of the higher tax brackets and our only income is from my job, does the new restrictions for state and local taxes impact any of the above answers?

Reading some of the threads on the site, it seems that being unable to itemize taxes paid (NY State Housing is about $23K per annum. incl local school district) and interest paid removes a lot of the benefit to leaving a mortgage open...

Background Details

  • I'm an American living and working in New York, USA.
  • We'd like to begin building up sources of passive income over the next five-to-ten years to allow us to offset my eventual loss of income when I'm put out to pasture from my currently well-paying job.
  • Our house is currently our only major investment - it has a 30yr ARM at 4.25% for the first seven years.
    • I intend to swap to a fixed-rate mortgage when interest rates are inevitably cut.
    • We will likely relocate overseas in 5-to-10 years, planning to keep our current house as a rental property

Thank you

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1. Yes, if you can't make a better investment return than your mortgage interest, the next dollar you're able to invest should instead go to pay the mortgage. The inflation rate does not play a direct role in this at all.

You might be thinking of a mortgage as a hedge against inflation (and it is a good one at that), but the math is the same: Invest unless interest rate is higher than return.

On high inflation environments, you might see investment returns naturally increase because of market forces (investors demanding a higher return considering the inflationary environment), but this doesn't change the above.

So far I'm talking about riskless investment returns. Once you add risk in, the calculation becomes trickier. Personally, I'd take a 4% guaranteed return (paying off debt) over a 7% potential equity return, especially if you already have substantial equity investments, but each situation is different.

2. Yes, investments have costs, including taxes. What you care about when making a comparison is the after-tax, net-of-costs investment return.

Equity index funds held long-term should have minimal costs, so taxes on long-term capital gains and qualified dividends would be your main cost there.

3. This reduces the tax advantages of deducting mortgage interest, but the question of paying off debt vs investing is even more fundamental. Essentially, do you leverage debt in order to invest more or not? Interest rates, potential investment returns, and investment risk are much bigger considerations.

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