Settling a mortgage with a negative real interest rate is often viewed as a less-than-ideal financial decision. Nonetheless, I made that choice in the current climate of unprecedentedly high inflation. Was it a mistake? Perhaps.
I had locked in a mortgage at a 30-year fixed rate of 4.25%, and with the recent 9.1% inflation rate, my real mortgage rate was effectively negative at 4.85% (4.25% minus 9.1%). I held onto this mortgage for 15 years before finally paying it off.
Conventional wisdom advises maintaining a mortgage with a negative real interest rate for as long as possible since inflation is effectively reducing your mortgage balance. But not all financial choices are strictly about maximizing profits.
If you’re pondering whether to pay down your mortgage with a negative real interest rate, let me share my rationale.
Why Settling Your Negative Real Mortgage Rate Might Make Sense
Here are compelling reasons you might want to consider paying off your mortgage, even if it has a negative real mortgage rate.
- Uncertainty in Risk Asset Returns: 2021 was a remarkable year for stocks, making it difficult to envision another superb year in 2022. Comparing a 5% expected return to a 4.25% mortgage rate, a guaranteed 4.25% return from debt reduction seemed appealing.
My enthusiasm for stocks waned as the year went on and stocks stumbled. Yet, I continued purchasing as I’ve done since 1999. With aggressive interest rate hikes by the Fed, a recovery seemed unlikely until inflation showed signs of slowing. Fortunately, those indicators are now appearing.
In this light, if risk asset returns seem uncertain, debt payment could be a smarter move. The higher the debt’s interest rate, the more appealing it becomes.
- Preferring Inflation Loss to Asset Price Decline: In times of high inflation, cash loses its value quickly. However, a decline in purchasing power of 9% due to inflation is still preferable to a 20% loss on an investment plus a 9% inflation hit.
I decided to allocate my idle cash to debt repayment, a sensible use for it, once the Fed’s aggressive stance weakened my confidence in the stock market.
- Strong Cash Flow or a Sudden Windfall: A high saving rate or an unexpected influx of cash may lead to debt payment as the easiest option. The guaranteed return equals the interest rate, and holding onto excess cash while in debt isn’t favorable.
With a saving rate over 50% and a large real estate distribution in July, I found myself with surplus cash and used it to pay down my negative real interest rate mortgage.
- Approaching Retirement or Decumulation Phase: Paying off all debt when nearing or entering retirement is wise. It frees up cash flow and removes one worry from retirement. I experienced a sense of relief and ease in cash flow after paying off one of my previous mortgages.
- Small Remaining Mortgage Balance: If your negative real mortgage rate becomes trivial or annoying, you may want to settle it. My mortgage felt like a nuisance with a balance of around $50,000 against a $550,000 property value. So, I decided to clear it, and it felt fantastic to eliminate that obligation.
- Expecting Lower Mortgage and Inflation Rates: If you foresee falling mortgage or inflation rates, it might be time to reduce your negative real interest rate mortgage. However, my decision was guided by the desire to remove a small, irritating burden rather than chase lower rates.
Not Paying Off My Main Residence Negative Real Mortgage Rate
I have no intention of paying off my primary residence mortgage, set at a 2.125% rate, as it feels like almost free money in the current environment.
If you’re considering settling your negative real rate mortgage, be cautious about the procedures involved. It might be better to overpay a bit and then get a refund.
Ensure that the liens are removed by consulting with the title company and the bank, and request a reconveyance letter from the mortgage holder.
While paying off a negative real mortgage rate may seem financially unwise, it felt right for me. The sense of relief from having one fewer mortgage outweighed the technical advantages.
Now, I can channel my surplus cash flow into entirely passive real estate opportunities like Fundrise, seeking simplicity and as much hands-off income as possible at my age.
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