I’ve been thinking a lot about what to do with my money post election, and one of the main considerations evolves around paying down mortgage debt.
Being mortgage free is generally a good thing. But there are times when you want to accelerate your mortgage pay down and there are other times when you want to leave it well alone. With the aggressive spike in interest rates post election, it’s now time to reassess whether paying down your mortgage quicker is a good idea.
Borrowers who took on debt and locked in a lower rate before the election are winning. Banks who lent people money before the election are losing because they could be earning a higher return today. In other words, the VALUE of the mortgage has risen for borrowers and declined for lenders.
When something rises in value, you do your best to hold on for as long as possible. Therefore, paying down your mortgage faster when your interest rate is fixed is a suboptimal move.
Here’s an example of a $500,000 mortgage that demonstrates this point.
5-Year ARM Interest Rate Lock Before Election: 2.5% = $1,975/month
5-Year ARM Interest Rate After Election: 3.25% = $2,176/month
Instead of prepaying down a fixed 2.5% rate, when the best a borrower can now get post election is 3.25% for the same loan, save the difference. The most conservative strategy is to save the $201 monthly difference for 60 months and then pay down $12,060 in principal the last month the 5-Year ARM adjusts if you plan to refinance or let the mortgage adjust. If you plan to sell the property by then, you’ll just keep the change.
A more aggressive strategy is to invest the $201 monthly difference in some now higher yielding bonds, given they have sold off due to the interest rate increase. An even more aggressive move is to invest the $201 monthly difference in a mix of stocks and bonds. Finally, the most aggressive strategy for a lot of people is to invest 100% of the difference in stocks and hope the raging bull market continues.
Your decision will depend on your risk tolerance and financial goals. For those of you wondering about 30-year fixed rates, they’ve risen from around 3.625% to 4.125% post election.