In a rising interest rate environment, you need a mortgage pay down strategy. With high inflation, mortgage rates and the Fed Funds rate have been rising. Therefore, you need a good game plan if you have mortgage debt.
Below is a case study on how to think about paying down your mortgage when mortgage rates are rising. You can use this older case study for a rising-interest rate environment in 2022 and beyond.
Mortgage Pay Down Strategy
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.
Example Of Not Paying Down Your Mortgage
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.
What Am I Doing?
Because I operate under the overarching belief that less debt is better than more debt, I will continue to pay down some extra principal on my 4.25%, 30-year fixed Lake Tahoe property mortgage that cannot be refinanced.
However, my original plan of paying an extra ~$50,000 a year in principal over the next six years to pay the sucker off by 2020 is now no longer happening.
Instead, I plan to reduce extra principal payments by 50% to $25,000 a year. The $25,000 in freed up capital will now be used to primarily focus on building a municipal bond portfolio in order to live for free in my primary residence.
I've also built a sizable $810,000 real estate crowdfunding portfolio. It earns me income 100% passively at a ~10% IRR.
I believe owning real estate in 2021+ is a wise decision. Funny money from stock gains will flow into real estate. Mortgage rates will stay low. Further, the value of real estate has gone way up since we're all spending more time at home.
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My Tailored Mortgage Pay Down Plan
I have a 5/1 ARM at 2.5% that is adjusting in July 2019. Although the interest rate is low, with only 25 months left of the fixed rate, I've got to come up with a plan to pay down extra principal payments so that if it were to adjust to 3.25%, I'll still be paying the same amount of interest.
Surprisingly, all I've got to do is pay down $19,000 of principal by July 2019 to maintain my same payment at 3.25% because I've already paid down $70,000. Plan done!
Finally, for my property with the newly refinanced 2.35% rate, I will no longer be paying down extra principal until the last month of the 5-year fixed term ending August 2021.
When the time comes, I will reassess the interest rate and real estate landscape to decide whether to pay down a lump sum, refinance or let the mortgage float.
Stay Fluid My Friends
The rise in interest rates post election proved temporary as investors realized many of Trump's economic policies aren't going through as quickly or as cleanly as first proposed (tax reform delay, health care reform delay, etc).
For those who missed the refinance window, you best try again and shop around for the latest rates. I do believe mortgage rates will eventually come down again as inflation subsides.
Pay attention to what's happening in the world and adjust your allocation of capital accordingly. I'll help keep you abreast through topical posts and my monthly newsletter. Don't be fixed in your way of thinking. So long as you have capital coming in, you have the luxury of figuring out how to best optimize your finances.
It's comforting to know that sooner or later, our mortgages will be paid off and we'll be able to drastically lower our cost of living or generate an increase in rental cash flow. We just have to decide how soon we want to experience that day.
Real Estate Recommendations
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Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns.
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Shop around for the latest mortgage rate. Check the latest mortgage rates online. You'll get real quotes from pre-vetted, qualified lenders in under three minutes. The more free mortgage rate quotes you can get, the better. This way, you feel confident knowing you're getting the lowest rate for your situation. Further, you can make lenders compete for your business.