Why Pay Off A Negative Real Mortgage Rate When Inflation Is So High


Paying off a mortgage with a negative real interest rate is a suboptimal financial move. However, that’s exactly what I did in this unusually high inflationary environment. Bad move? Maybe.

The mortgage rate was a 30-year fixed at 4.25% and the latest inflation figure 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 was recently paid off.

In general, you want to keep your mortgage with a negative real interest rate for as long as possible because inflation is paying down your mortgage for you. However, sometimes, not every financial decision is about maximizing returns.

If you find yourself wondering whether you should also pay down your mortgage balance with a negative real interest rate, let me share with you the reasons why I did.

Why You May Want To Pay Off Your Negative Real Mortgage Rate

Here are the best reasons why you should consider paying down your mortgage, despite it having a negative real mortgage rate.

1) Uncertain about risk asset returns.

After a banner 2021, it was hard to see another fantastic year for stocks in 2022. Therefore, when I compared a 5% expected return to a 4.25% mortgage rate, getting a guaranteed 4.25% return by paying down debt was relatively attractive.

As the year progressed and stocks declined, my enthusiasm for stocks also faded. But I kept buying on the way down as I usually have done since 1999. After the Fed committed to raising rates aggressively, it felt like risk assets wouldn’t recover until there were definite signs inflation was rolling over. Thankfully, the signs are now here.

Therefore, if you are uncertain about risk asset returns, paying off debt is a relatively better move. The higher the interest rate on the debt, the more attractive it is to pay down.

Always compare your realistic expected returns to your mortgage rate. Sadly, many investment houses are predicting much lower risk asset returns over the next 10 years.

2) Losing money to inflation is better than losing money to asset price declines.

When inflation is high our cash loses purchasing power. As a result, we tend to want to spend our cash sooner to buy goods before they get even more expensive.

However, it is still much better to lose purchasing power due to inflation than actually lose money from an investment that is going down in value. Sure, your cash’s purchasing power might be down 9% from a year ago. But you would rather be down 9% in purchasing power than be down 20% on your investment plus 9% from inflation.

Given my faith in the stock market declined once the Fed started getting aggressive, I logically decided to use my idle cash to pay down debt. This way, the cash was at least being put to good use. I’m following my FS DAIR methodology to paying down debt.

3) Have strong cash flow or receive a large injection of cash.

If you have a high saving rate or suddenly come into a lot of cash, paying down debt is the easiest move to make. The guaranteed return on paying down the debt is the interest rate. Meanwhile, you don’t want to have too much cash sitting around for too long if you still have debt.

Our saving rate is over 50% and I received a large private real estate distribution of $122,423 in July. Therefore, I had excess cash.

I told myself I would invest 20% of the proceeds into the S&P 500 if it got back down below 3,700. As the market rebounded higher, I didn’t want to chase it. Therefore, I used 12.3% of the real estate distribution to pay down my negative real interest rate mortgage instead. If I waited, I could be waiting for a long time (hopefully).

4) In decumulation phase or are heading into retirement.

It’s a good idea to pay off all debt when you no longer can or want to work. Once you pay off your mortgage, you free up cash flow equal to the monthly mortgage payment. Getting rid of a mortgage is one less thing to worry about in retirement. It feels like a burden has been lifted.

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 given I had an extra $2,200 a month in cash flow. No matter as having a child in 2017 reignited the flame to grind.

Today, after more than 2.5 years into the pandemic, I’m absolutely exhausted. Writing my book for two years while raising two young children has kicked my ass. I didn’t even want to write this post. But I made a promise to keep going, so I soldiered on!

By paying off this latest mortgage, I free up $2,480 a month in cash flow. Sure, most of the monthly payment went to paying down principal and not interest. That said, having more cash flow is nice in this uncertain environment where I’m burned out. Now the extra cash flow will be used to pay 110% of our monthly unsubsidized health care bill.

5) Negligible remaining mortgage balance.

If your negative real mortgage rate becomes an annoyance or an insignificant amount, you may want to pay it off. If you’re so close to paying it off and have the cash, you might as well do so now to get the monkey off your back.

At the beginning of the year, my negative real interest rate mortgage had a balance of about $50,000. Meanwhile, the vacation property is worth about $550,000. With a loan-to-value ratio of only 9%, the mortgage started feeling like a pest.

Therefore, every month for seven months, we paid down an extra $5,000 in principal on average. With ~$15,000 left, we decided to just pay it off after getting our latest private real estate fund distribution. And you know what? It feels damn good to get rid of this loan.

We have a complicated net worth, so the less we have to deal with the better. You’ll appreciate the joy of simplicity if you ever set up a revocable trust, write a will, or create a death file.

The feeling of paying off a mortgage is similar to the feeling of getting rid of a troublesome rental property. Joy. You feel like you have more capacity to focus on better things.

6) If mortgage rates and inflation rates are going lower.

The final reason why you may want to pay down your negative real interest rate mortgage is if mortgage rates and inflation are going lower. If rates are going lower, your existing mortgage rate becomes relatively more expensive. Therefore, you would either want to pay down extra principal or refinance to a lower-rate mortgage.

However, in 2022, mortgage rates zoomed higher by about 2.25% before falling by about 1% from its highs so far. Higher mortgage rates and inflation makes my existing 4.25% more attractive. After all, the average 30-year fixed rate mortgage reached a high of about 5.83% according to Freddie Mac.

Despite having a relatively more attractive mortgage, I still paid it off because the balance was small compared to the value of the property. I just wanted the pesky burden to go away so I could focus making money elsewhere. If my mortgage amount was in the hundreds of thousands of dollars, I probably would have kept it.

The 4.25% mortgage I just paid off was also my highest mortgage rate out of three mortgages. The combination of highest mortgage rate and lowest balance made paying it off an easier decision.

Not Paying Off My Primary Residence Negative Real Mortgage Rate

I will gladly not pay down my existing primary residence mortgage with a 2.125% mortgage rate. It is a 7/1 ARM that can reset to at most 4.125% in 2027. Paying off a negative real mortgage rate of about 7% is just way too much. A 2.125% mortgage rate feels like free money in this environment.

By 2027, when the ARM is set to reset, there’s a 60% chance I might buy another “forever home.” If I need funds, I will end up selling my existing residence, thereby paying off the principal mortgage in full anyway.

Finally, if you plan to pay down your negative real rate mortgage, please beware of some mortgage payoff procedures. Paying off the exact balance can be tricky. It’s better to overpay a little and get a refund.

Most importantly, confirm the liens are removed with the title company and the bank. You can do so by requesting a reconveyance letter from the mortgage holder.

Although paying off a negative real mortgage rate is a suboptimal financial move from a returns perspective, it felt right for me. The feeling of having one less mortgage more than outweighs having a mortgage balance that’s getting inflated away.

Questions And Action Items

Readers, have you been paying down your mortgage with a negative real mortgage rate in this high inflationary environment? Why or why not?

After paying off three mortgages, I’ve come to realize I like to pay mortgages off in about 10-15 years. Waiting for 30 years feels too long. Therefore, getting a 7/1 or 10/1 ARM is more optimal given the interest rate is lower. ARMs also motivate me to pay down extra principal.

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