Is Now the Right Time to Pay Off Your Mortgage?

September 30, 2016
SHIRLEY MUELLER, MD

Whether or not a mortgage is worthwhile to you depends on its interest rate and expected forward interest rates, as well as your stage in life and other factors.

Whether or not a mortgage is worthwhile to you depends on its interest rate and expected forward interest rates, as well as your stage in life and other factors.

A fixed rate mortgage provides inflation protection. If interest rates rise, a lower rate mortgage is attraction. But, what if interest rates stay low?

That may be the future. There is a school of thought today that interest rates, even if they rise, will not do so appreciably. In addition, some commercial banks in the Eurozone have to pay to keep their excess funds on deposit at the central bank overnight. Instead of being compensated for parking their money, they pay for the privilege, an almost unheard state of affairs — a negative interest state. It is possible that the US could begin to deploy this tactic as well.

This possibility should give someone who holds a mortgage pause. Are we beginning a low to no inflationary or even deflationary cycle? If the latter were true, paying off a mortgage could make sense for those who are able to do so.

This is why. A mortgage is a risk in a deflationary cycle because debt is being paid back with dollars that are more valuable than when the money was borrowed. For example, a middle-aged to pre-retired or retired doctor buys a house for $900,000. To be conservation, she obtains a conforming loan with a fixed 30-year term at 4%. She is in the 28% federal income tax bracket so her after-tax mortgage rate is effectively less, approximately 2.9%. The crux is, can she safely find this kind of after tax return in the market to wait out no to little inflation or even deflation before inflation comes around again?

Let’s examine that. The average dividend yield of the S&P 500 is about 2%. This means that a relatively secure return from stocks is less that the effective 2.9% the borrower is paying. The recent interest from a medium term treasury is even less than 2%. Therefore, after tax return of each is less than 2%. It seems that in the present environment, there is no secure way to pay the full interest from investments. The gap between current available interest on the S&P 500 or the intermediate treasury compared to the interest on the loan is about 0.9% per year, a loss to the debtor and a complete bummer unless interest rates rise soon.

The upshot of all this is for those who see inflation as distant and want security now, paying off a part or all of a mortgage may be beneficial. It beats owing money when the borrowed dollars are worth more than when they were lent originally.

This information and content is offered for educational purposes only by MyMoneyMD, LLC. MyMoneyMD, LLC is not acting as a Registered Investment Advisor, Investment Counsel, Tax Advisor, or Legal Advisor.