Paying off a mortgage with a negative real interest rate is a suboptimal financial move. But that is exactly what I did in this unusually hyperinflationary environment. Bad move? Maybe.
The mortgage rate was set at 4.25% for 30 years and the latest inflation rate was 9.1%. Therefore, it had a negative real mortgage rate of 4.85% (4.25% – 9.1%). I had the mortgage for 15 years until it recently paid off.
In general, you want to keep your mortgage at a negative real interest rate for as long as possible because inflation will pay off your mortgage for you. However, sometimes not all financial decisions are about maximizing returns.
If you’re wondering if you still owe your mortgage with a negative real interest rate, let me explain why.
Why You Might Want to Charge Your Real Mortgage Interest Rate Negative
These are the main reasons why you should pay your mortgage despite a negative real mortgage rate.
1) Uncertainty about the profitability of risk assets.
After a stellar 2021, it was hard to see another great year for stocks in 2022. So when I compared a 5% expected return to a 4.25% mortgage rate, getting a guaranteed 4.25% return on the debt was relatively attractive.
As the year progressed and stock prices fell, so did my enthusiasm for stocks. But I continued to buy low, as I normally have since 1999. After the Fed committed to aggressively raising rates, I felt that risk assets would not recover until there were clear signs of inflation. Luckily, the signs are there now.
So if you’re unsure about returns on risky assets, paying down debt is a relatively better course of action. The higher the interest rate on the debt, the more attractive the payment will be.
Always compare your realistic expected rate of return to your mortgage rate. Unfortunately, many investment houses are forecasting much lower returns on risky assets over the next 10 years.
2) Losing money to inflation is better than losing money to falling asset prices.
When inflation is high, our cash loses purchasing power. As a result, we are more likely to spend our money on buying goods before they become even more expensive.
However, losing purchasing power through inflation is still much better than losing money through an asset that is depreciating in value. Sure, the purchasing power of your cash could decline 9% year over year. But you’d rather have 9% less purchasing power than 20% less of your investment plus 9% inflation.
Since my confidence in the stock market faded when the Fed started getting aggressive, I logically decided to use my idle cash to pay down debt. That way, the money was at least used wisely. I follow my FS DAIR methodology to pay off debt.
3) Strong cash flow or large cash injection.
If you have a high savings rate or suddenly find yourself with a lot of money, paying down debt is the easiest step. The guaranteed return on paying off debt is the interest rate. In the meantime, you don’t want to have too much cash for too long if you’re still in debt.
Our savings rate is over 50% and I received a large personal real estate payment of $122,423 in July. So he had excess cash.
I told myself I would put 20% of the gains back in the S&P 500 if it fell below 3700 again. When the market rallied, I didn’t want to chase it. So instead, I used the 12.3% real estate distribution to pay off my negative real rate mortgage. If he waited, he could (hopefully) wait a long time.
4) In retirement or in the process of retirement.
It is a good idea to pay off all debts if you are no longer able or willing to work. Once you pay off your mortgage, you free up cash flow equal to your monthly mortgage payment. Getting rid of a mortgage is one less thing to worry about in retirement. It feels like a weight has been lifted off your shoulders.
When I paid off one of my other mortgages in 2015, I felt lighter. However, the “downside” was that I also felt lazier. I lost some fire to work hard as I had extra cash flow of $2,200 a month. No matter how the birth of a child in 2017 rekindled the flame.
Today, after more than 2.5 years in the pandemic, I am absolutely exhausted. Writing my book for two years while raising two young children kicked my ass. I didn’t want to write this post at all. But I promised to keep going, so I kept going!
By paying off this final mortgage, I am freeing up $2,480 in cash flow each month. Sure, most of the monthly payment went to principal and not interest. However, it’s nice to have more cash flow in this uncertain environment where I’ve been burned out. Now the extra cash flow is used to pay 110% of our monthly unsubsidized health care bill.
5) Insignificant balance of the mortgage.
If your negative real mortgage rate becomes a nuisance or an insignificant amount, you may want to pay it. If you’re that close to paying it off and have the money, you might as well do it now to get the monkey off your back.
At the beginning of the year, my negative real rate mortgage had a balance of about $50,000. The vacation home is now worth around $550,000. With a loan-to-value ratio of just 9%, the mortgage was starting to seem like a hassle.
As a result, we deposit an average of $5,000 in additional capital each month for seven months. With about $15,000 remaining, we decided to cash it in after receiving our last private real estate fund distribution. And you know what? It feels great to get rid of that loan.
We have a complicated fortune, so the less involved, the better. You’ll appreciate the joy of simplicity every time you set up a revocable trust, write a will, or complete a death record.
Paying off a mortgage feels like getting rid of a troubled rental property. Happiness. You feel like you have more ability to focus on better things.
6) When mortgage rates and inflation rates fall.
The last reason you should pay off your negative real rate mortgage is when mortgage rates and inflation are falling. When interest rates go down, the existing mortgage rate becomes relatively more expensive. So you want to pay an additional amount of principal or refinance to a lower rate mortgage.
However, in 2022, mortgage rates rose about 2.25% before falling about 1% from their previous highs. Higher mortgage rates and inflation make my current 4.25% more attractive. After all, the average 30-year fixed-rate mortgage peaked at around 5.83%, according to Freddie Mac.
Even though I had a relatively better mortgage, I still paid it off because the balance was small compared to the value of the property. I just wanted the annoying burden to go away so I could focus on making money elsewhere. If my mortgage was hundreds of thousands of dollars, I probably would have kept it.
The 4.25% mortgage I just paid was also my highest mortgage payment of three mortgages. The combination of the higher mortgage rate and the lower balance made the payment decision easier.
I am not paying the negative real mortgage rate on my primary residence
I will happily not pay off my existing primary residence mortgage at a 2.125% mortgage rate. It’s a 7/1 ARM that can be reset to a maximum of 4.125% in 2027. Paying a negative real mortgage rate of around 7% is too much. A 2.125% mortgage rate feels like free money in this environment.
By 2027, when the ARM resets, there’s a 60% chance you’ll buy another Forever Home. When I need money, I end up selling my current apartment and paying off the primary mortgage in full anyway.
If you plan to pay off your mortgage with a negative real interest rate, consider some mortgage payment procedures. Paying the exact balance can be difficult. Better to pay a little more and get a refund.
Most importantly, confirm that the liens have been removed with the title company and the bank. You can do this by requesting a withdrawal letter of the mortgagee.
While paying a negative real mortgage rate is a suboptimal financial move from a performance perspective, it felt right to me. The feeling of having a lower mortgage is more prevalent than an increasingly inflated mortgage balance.
questions and action items
Dear reader, in this highly inflationary environment, have you paid off your mortgage with a negative real mortgage rate? Why or why not?
Now that I’ve paid off three mortgages, I’ve found that I like to pay off mortgages in about 15 years. Waiting 30 years feels like too long. So getting a 7/1 or 10/1 ARM is more optimal as the interest rate is lower. ARMs also motivate me to deposit additional capital.
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