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Paying Off Your Mortgage Is A Bad Move When The Yield Curve Is Inverted

Updated: 06/28/2022 by Financial Samurai 55 Comments

Paying Off Your Mortgage Is A Bad Move When The Yield Curve Is Inverted

In general, I’m a fan of paying off your mortgage, no matter the situation. However, paying off your mortgage is a bad move whenever the yield curve is inverted. Paying off your mortgage is a suboptimal decision when you have a negative real mortgage interest rate as well.

I’ll use a case study to explain why.

If my quest to refinance my primary home mortgage doesn’t make my views obvious, I believe paying off your mortgage is a bad financial move when the yield curve is inverted.

I’m in an interesting position where I have both, paid off properties and mortgaged properties. I also have the ability to pay off my mortgages tomorrow. Therefore, I can argue both the quantitative and the qualitative side to paying off a mortgage or not without much bias.

At the end of the day, I want everyone to make the best financial moves in order to decrease financial anxiety, boost wealth, and increase happiness. As a family man now, I care about these three things for readers more than ever before.

Why You Shouldn’t Pay Off Your Mortgage When The Yield Curve Is Inverted

When the yield curve is inverted we have some serious economic implications to consider. Let’s talk about the primary reason why you shouldn’t pay off your mortgage along with a few other reasons.

1) Best relative value to borrow.

The yield curve is normally upward sloping at all time intervals due to the time value of money. As a lender, you require a higher rate of return for longer duration loans due to inflation and the increased risk of not being paid back.

The yield curve very seldom inverts and when it does, it means that longer duration borrowers are getting the relatively best deal.

Let’s study a normal yield curve below. Short-term rates during this time period were very low partially because the Federal Reserve kept its Fed Funds rate at near 0%.

The spread between the 10-year yield and the 3-month yield was 2.1%. In other words, as a borrower, you had to pay a 2.1% premium to borrow for 10-years.

Paying off your mortgage is a bad move when the yield curve is inverted

Now let’s look at a slightly inverted yield curve on July 1, 2019. Instead of paying a 2.1% premium to borrow for 10 years, you’re getting a 0.12% discount to borrow for 10 years (2.12% – 2%).

Borrowing for three years (1.71%) might seem to be even more enticing given the larger discount (2.12% – 1.71% = 0.41%). However, you would be losing seven years of a fixed rate, so there is a tradeoff.

Yield curve 2019 vs 2018

The inverted yield curve is screaming at you to take advantage of the point of inversion and to save as much money as possible in short-term money market accounts and treasuries.

2) Best relative risk-free return.

Back in 2015, your money market account and short-term treasury bonds paid practically nothing. I clearly remember when I was only getting 0.1% at my main bank where I had seven figures in assets.

As a result, logical investors decided to take on more risk by buying stocks and real estate. Stocks and real estate have performed handsomely ever since but hit a rough patch in late 2018 as investors pulled back.

With short-term rates higher than long-term rates, investors are naturally reconsidering the wisdom of taking so much risk when expected future profits and economic indicators are slowing.

Investors can now earn ~1.3% risk-free in savings and <1% in 3-month treasury bonds. Not that great any more.

Since the end of 2015, the total added value a consumer has been getting is roughly 4.6% (2.2%from borrowing at the point of inversion and 2.4% from saving). This value increase is significant.

3) Liquidity grows in value.

Although an inverted yield curve does not guarantee the U.S. economy will go into a recession, every recession has been preceded by an inverted yield curve.

During a recession, companies naturally reduce capital expenditure and hiring. If the recession gets bad enough, as it did in 2008-2009, potentially millions of people will lose their jobs.

With uncertain times, the value of cash goes up because cash provides individuals with more options. Cash allows people who get laid off to wait out the storm until the economy recovers.

The people who were forced to sell stocks and real estate between 2008 – 2012 probably did not have a high enough cash balance. They are surely trying to kick themselves in the face today.

Unless you pay off your mortgage in full, you will continue to have the same mortgage payment amount each month. The only difference is that the percentage of your payment going to principal will be increasing.

Therefore, one of the riskiest scenarios is for you to pay down your mortgage without fully paying it off and then experience a job loss. If this happens, you will probably feel a tremendous amount of financial anxiety because your investments are likely taking a hit while your housing expenses are still the same.

Yield Curve Inversion

4) Vulture buying firepower.

Whether in a bull market or a bear market, there are investment opportunities every day. You always want to have at least 10% of your investable assets in liquid cash ready to pounce.

However, after a 10-year bull market and/or when the yield curve inverts, you probably want to have at least 30% of your investable assets in liquid cash. After all, your cash is earning at least 2.45% risk-free.

The investment opportunities during the 2001-2002 dotcom bubble crash and the 2008-2010 housing bust were plentiful. There will be more plentiful opportunities again. You just need to have the courage to leg in when everyone is running the other way.

Recessions only last for about 18-22 months on average. If you’ve paid off your mortgage and didn’t buy any bargains during the recession because you didn’t have enough money, you will likely feel bad about your inactivity once the economy picks up.

5) Peace of mind is overrated.

You will feel at most six months of excitement after you’ve completely paid off your mortgage. After six months, it’s back to business as usual. The same thing happens after you get a promotion, a raise, a business win, or win a championship.

The highs never last forever. Likewise, your peace of mind will not last forever either. If you want more peace of mind, get an adjustable rate mortgage and save on interest. It doesn’t make sense to lock in a higher mortgage for 30 years when you only plan to live in the house for 10 years.

When times are really bad, you might actually have more peace of mind if you don’t have a significant amount of your net worth tied up in one asset.

When times are really good, you may start feeling bad that you aren’t more levered to earn a greater return on your property.

After paying off a condo in 2015, I wrote about the mortgage payoff fees and procedures to expect so folks don’t get blindsided. But after about a month, I no longer felt any joy from having no mortgage.

When it came time to do my taxes eight months later, I wondered where my 1098 mortgage interest statement was because I had forgotten I had paid it off! I actually felt a little dismayed I didn’t have that deduction anymore.

6) Inverted Yield Curve Portends To A Recession

When the yield curve inverts, a recession is highly probably. Therefore, if you start paying down extra principal toward your mortgage, you reduce your liquidity. Unfortunately, your monthly mortgage payments stay the same.

As a result, you put yourself in a WORSE financial situation if a recession were to occur. During a recession, you want to have as much liquidity as possible to survive and take advantage of opportunities in a downturn.

Yield Curve Inversions and Recessions

Arbitrage The Yield Curve Kink

You want to save aggressively in money market accounts or short-term treasuries to take advantage of higher rates and borrow money at longer-term durations to take advantage of the inversion.

To go the opposite way and borrow short-term money at a higher rate and lend longer term money at a lower rate is completely illogical. Only non-savvy financial readers do this.

But this is exactly what banks are being forced to do, which is why since the yield curve inverted, the banking sector has started to significantly underperform the S&P 500.

Notice in the below chart how XLF (banking ETF) started to underperform the S&P 500 once the yield curve inverted.

If you don’t want to take my advice, then at least be aware of what the stock market and billions of dollars of lost value is telling you.

Banks started to underperform the S&P 500 once the yield curve ivnerted

A Lower Mortgage Balance Is Better

In general, less debt is better than more debt. To not have debt in retirement is a wonderful thing.

But if you are like most people who are still working and who don’t have unlimited funds, then hanging onto your mortgage or refinancing into a mortgage with a fixed duration that matches the point of inversion makes the most financial sense.

If the yield curve gets extremely inverted, then it’s up to everyone to go all-in and arbitrage the kink. Can you imagine if the 3-month bond yield stayed at 2.5% while the 10-year bond yield collapsed to 1.5%?

Banks would be paying us 1% to live in our homes.

Don’t buy when things are full price. Always buy when things are on sale.

An inverted yield curve only comes around about once every 10 years. Refinancing your mortgage during this sale is the most logical conclusion if the numbers make sense. Make sure to run the after-tax results as well.

The Yield Curve Today

Post pandemic, the yield curve is now upward sloping and relatively steep. The Fed slashed rates to 0% – 0.25% and long-bond yields have risen from their 2020 pandemic lows. Now, the Fed wants to raise the Fed Funds rate above 3.25% by 2023 to stem inflation.

I’m personally very positive on the housing market. I believe the mortgage rates will stay low for a long time, even though they are up from 2020. The economy is recovering, wages are growing, and corporate earnings are rebounding aggressively. Inflation is a great tailwind for rental growth and property price appreciation.

With a steepening yield curve and potentially rising rates, paying off your mortgage is incrementally better. However, also beware of the biggest downside to paying off your mortgage. That downside is losing the motivation to hustle since you have less debt and increased cash flow.

Invest In Real Estate More Strategically

Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income. Stocks are fine, but stock yields are low and stocks are much more volatile. 

The combination of rising rents and rising real estate prices builds tremendous wealth over the long term. Meanwhile, there are more ways to invest in areas of the country where valuations are lower and net rental yields are higher thanks to crowdfunding. 

Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore.

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. The real estate platform has over 300,000 investors and manages over $3 billion. 

CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends.

I’ve personally invested $810,000 in real estate crowdfunding across 18 projects to take advantage of lower valuations in the heartland of America. My real estate investments account for roughly 50% of my current passive income of ~$300,000. 

Shop Around For The Best 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. Paying off a mortgage is a bad move when the yield curve is inverted.

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Filed Under: Mortgages, Real Estate

Author Bio: I started Financial Samurai in 2009 to help people achieve financial freedom sooner. Financial Samurai is now one of the largest independently run personal finance sites with about one million visitors a month.

I spent 13 years working at Goldman Sachs and Credit Suisse. In 1999, I earned my BA from William & Mary and in 2006, I received my MBA from UC Berkeley.

In 2012, I left banking after negotiating a severance package worth over five years of living expenses. Today, I enjoy being a stay-at-home dad to two young children, playing tennis, and writing.

Order a hardcopy of my new WSJ bestselling book, Buy This, Not That: How To Spend Your Way To Wealth And Freedom. Not only will you build more wealth by reading my book, you’ll also make better choices when faced with some of life’s biggest decisions.

Current Recommendations:

1) Check out Fundrise, my favorite real estate investing platform. I’ve personally invested $810,000 in private real estate to take advantage of lower valuations and higher cap rates in the Sunbelt. Roughly $160,000 of my annual passive income comes from real estate. And passive income is the key to being free.

2) If you have debt and/or children, life insurance is a must. PolicyGenius is the easiest way to find affordable life insurance in minutes. My wife was able to double her life insurance coverage for less with PolicyGenius. I also just got a new affordable 20-year term policy with them.

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Comments

  1. Jamie says

    December 12, 2020 at 11:35 am

    I love your site cuz I could never figure stuff like this out on my own. You have a natural way of explaining things for non-finance people like me to understand. I’m working on refinancing my house now. Thanks man!

    Reply
  2. Max Price says

    December 20, 2019 at 3:35 pm

    My father who is a CPA has (I’m guessing millions of dollars) in investments refuses to pay off his mortgage on a $230k condo that he bought 25 years ago. He keeps refinancing it and I get it. But never the less it is more about the principle to me. I’ve been in debt before. It’s an awful feeling. Having encumbrances on the roof over my head is unsettling to me personally and I’d rather pay it off, even with a 50% LTV and having a fairly low payment. Thinking back to the mortgage crisis and the paperwork mixups and people who were getting foreclosed by mistake. I’m more of a worrier than a risk taker. But there’s a reason I haven’t retired at whatever young age that you are.

    Reply
  3. Victoria says

    September 22, 2019 at 1:10 pm

    Hello Sam,

    I agree with you I had a plan to pay off my mortgage early but instead I’ve been paying myself first by investing extra money each month into my Vanguard account.
    I bought real estate in 06 before the market crashed but I held on even though my real estate was under water and I got a great refinance through a government program back in 2010 with next to nothing in fees and an unbeatable rate compared to today’s rates. Right now I’m waiting for the real estate market to open up more inventory so prices will drop but at the time in my area in the Pacific Northwest prices are too high to invest in real estate. Holding steady and saving is the best way forward for me. Thanks for your advice. Enjoy the last of summer!

    Reply
  4. Ray says

    July 31, 2019 at 1:51 pm

    I have been reading your advice on ARM vs. FRM very closely Sam. Thank you for this as I never would have thought about mortgages this way without your blog. Curious what you and your readers think about my situation. I have a 30-year FRM at 3.125%. Therefore, the interest I pay on my P&I FRM monthly payment is similar to what I would pay on an Interest Only ARM (lowest I am seeing is 3.375%). Although as a whole my monthly payment would go down by $1000 since it is an I/O loan. My currently monthly payment is also ~$200 higher than any 5 or 7 amortizing ARM that I see out there right now. I do not think it makes sense to lower my monthly payment even if I save $1000 per month by going I/O for 7 years as the difference is really just going to buying more equity in my house, which is in a really tight part of LA, thus I get the benefit of future capital appreciation. Am I thinking about this the right way? Would like to stay in this house for as long as possible too.

    Reply
  5. John says

    May 5, 2019 at 5:10 pm

    We are in an interesting spot where we owe about $380K on a $2M home and have a 10 year interest only at 3.25%. We have prioritized paying this down as the rates could adjust at the end of 10 years (2025) so have been paying down $100K a year. We should be done in about 4 years or so. We make good money – more than $700K a year combined. So even after the $100K annual paydown, we save a a lot. But we are risk averse and keep it at PNC and earn 2.35% interest. I’ve always thought getting 2.35% yield pre tax is not worth it vs paying 3.25% mortgage interest. But putting free cash in the stock market right now makes no sense to me. Sam – do you think this strategy makes sense? Should we continue to pay down or keep the cash to invest later when the market slows down?

    Reply
    • Diana says

      September 22, 2019 at 10:25 am

      I am in a similar situation and thoughts process as yours John. I’m interested in knowing what you have decided in the end. Thanks!

      Reply
  6. Misti says

    April 19, 2019 at 3:02 pm

    My husband and I paid off our house a few years ago and I am thrilled every single day to be 100% debt free. I wouldn’t do it any other way.

    Reply
    • Financial Samurai says

      April 19, 2019 at 8:36 pm

      I’m happy for you. This post is specifically regarding those deciding whether to pay off the mortgage or not in a flat or inverted yield curve environment.

      Reply
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