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 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 from 2015 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.
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.
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 2.3% risk-free in savings and 2.12% in 3-month treasury bonds. Not bad for not having to take any risk or do any work while having maximum liquidity.
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.
4) Vulture 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.
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.
Arbitrage The 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.
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.
Financial Suggestions
Refinance your mortgage: Check online for the latest mortgage rates and refinance into a mortgage that has a fixed duration matching where the longer term yield is inverted. This means looking for 5/1 ARM – 10/1 ARM rates. LendingTree has one of the largest lending marketplaces today. They have lenders competing for your business.
Look into real estate: As interest rates decline, demand and buying power for real estate goes up. Take a look at real estate crowdfunding to find value in the heartland of America where valuations are cheaper and net rental yields are higher. Fundrise is the top real estate crowdfunding platform today. It’s free to sign up and explore.
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.
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?
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.
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.
Hi,
I have a $550k home fully paid off. It is 50% of our net worth. We are in mid 40s with over $250k in combined income. Does cash out refi at 3.875% with 75% LTV and investing that equally in rental real estate and stocks make sense? We top off our 401ks and IRAs. Retirement accounts at $500k and emergency cash account at $80k.
Depends how good the rental property investments are. I would look into real estate crowdfunding or REITs to simplify life.
Great and insightful post, Sam. And an inverted yield curve is not the exception – rushing to pay off a mortgage is actually rarely a good idea in a developed country.
I want to broadcast a question since this post touched the topic: do you (or anyone) know about a high-yield savings account available to Europeans? The CIT savings builder is only available to US residents.
Keep up the great work!
We refi’d our principal residence in 2012 to a 15 year 3.125% note. Since then my income has more than tripled, and we’ve aggressively paid down the mortgage. Down to the last $10K this month and will pay it off by 6/30/19.
We bought our first home in 1995 and sold that one in 2005 (with 4x appreciation!).
So our goal was to not have 30 years of mortgage! We’ll be mortgage free in a total of 24 years across both homes.
We max out pre-tax retirement and college funds every year, so the extra $13K per year we paid in principle/interest will just be added to our taxable investment account budget.
I know perhaps the math doesn’t make sense, but there’s something to be said for taking that (albeit small) risk off the table, and have a home that is full paid.
THiks post shows your real ability to cut across traditional lines of thinking.
Taxes are a big part of this. I am in a SALT heavy state and I just finished my taxes. It seems the pain is real.
Finally! I’ve been reading your blog for years and cringed every time you talked about paying off your mortgage. I know it’s popular with many early retirees but I rarely see an argument to do it besides “peace of mind”. I can maybe buy it if your home is a minor portion of your net worth (or if you’ve already “made it”) but for most people their home is their biggest asset.
I have many family and friends who adhere to the “peace of mind” strategy. They pay off their 3.5% mortgages, they don’t invest in stocks or real estate because of the risk, they don’t look for better jobs because they don’t want to take the risk. Like myself, they are mostly middle class folks who’ve are now upper middle class. Unlike me, they won’t be retiring early. No risk. No reward.
Conversely, most financial bloggers intimately understand the risk/reward paradigm and owe their financial success to it, but it baffles me how many make an exception for their primary residence. My philosophy is that if you can’t make at least 3.5% annually on your money over 30 years, then you’re not really trying.
David – I agree with you even though I disagree…
My principle residence is worth maybe 20% of my estimated net worth, so for me, it was a relatively easy goal to get that off my plate, so to speak. I’m just going to allocated the cash flow to “riskier investments”, and already save 20%+ of my income to retirement.
Yes, at 20% of your net worth, that seems a like a manageable payoff. Everybody should have a portion of their net worth in a “safe” investment like cash, bonds, or a paid mortgage.
However, for most Americans, their home is their largest single asset. If they concentrated their financial resources on paying off their mortgage, they would not be financially diversified, and they would miss out on significantly higher returns from investing in other asset classes. Unfortunately, too many people put too much money in the “safe bet” category, although I suppose it’s better than the “bad bet” category.
We are in that boat where our home represents about 20% of our networth. We own about 60% of our home, and should pay it off in 10 years with a total of a 17 of 30 year mortgage. We fully fund our 401ks to the Federal limit, and save more each month on top of that. Paying off our mortgage at this rate will have ours paid off a few years before we hope to retire. I have traded down bond funds in our total investments for this, so that most of the rest of our money is in the market, aside from our emergency fund. I guess time will tell
Sam, do you think it makes sense to pay 4.1-4.3% interest to mortgages (30 year fixed today according to Bankrate), while investing in bonds that only yield 2-3%, and paying tax on that interest?
If your’e comparing to risk-free rate, a 3 month 2.5% treasury risk free rate gets hit with a 32 + 3.8% or 35 + 3.8% = 35.8% or 38.8% federal tax bill for many upper-income earners, effectively yielding 1.53%.
“You always want to have at least 10% of your investable assets in liquid cash ready to pounce.” Strongly disagree. So after you “pounce”, do you go and sell 10% of your other stock again? You’re always going to perpetually have a 10% drag on your investment returns by staying out of the market with a tenth of your portfolio.
There are a few reasons outlined here, but frequently it doesn’t seem that convincing. You can just get a $25-50K HELOC for an emergency stash, and you should have an emergency fund anyway. You don’t need that much liquidity. Too much liquidity = rash decisions, like pouncing on FOMO investment opportunities and buying at the top.
I would never pay 4% for 30 year fixed mortgage or get a 30 year fixed mortgage. It’s such a waste of money the premium.
But you are free to do whatever you want. That’s the great thing about everything. Look at your returns and your net worth and if you’re happy, that’s all that matters.
Great post Sam!
I just refinanced my mortgage to a 1.40% fixed rate for 6 years, while taking out some capital from appreciation. After the refi I’m still <80% LTV, got a bunch of cash, and pay LESS interest than before.
Times like these are wonderful.
Obligatory mention: I'm from Europe, are interest rates are even lower than they are in the US.
Mathematically exploiting the yield curve inversion sounds super financyish. My wife and I follow a much simpler formula, which is the same thing for dumb people like me. Pile up cash for emergencies and for deals. All those APRs and APYs, fixed rates, variable rates, etc. make my head spin. Putting 4,000 monthly into savings seems like prepping for an opportunity. All the while still putting extra on the mortgage to make it vanish in a few years, regardless of inversions or other curve balls.
And a ROTH IRA ha ha ha ha! I had to throw that in if your selling and moving!
Don’t sell, just move and invite some of your dumbest readers like me over for a pig roast!
Be well FS and family!
Sam, Thanks for bringing to reader’s attention that now is a good time to refinance because I’m not the type of person to keep close tabs on mortgage rates but it’s mostly due to having a primary home that’s paid off and a rental property that’s still 53% underwater so it’ll be years before I’m eligible to refinance. You make very good points for refinancing. I like that you try to think about readers in various financial situations and not just those similar to your situation. This post reminds me of Paula Pant’s message about widening the gap between earnings and expenses. While I’m not able to refinance, we converted the rental property into an Airbnb about one month ago and it’s bringing in 44% in profit so far.
I have a 15 year fixed mortgage at 2.75% that I’ve had since 2012. I’ve never paid a cent more then required. With ~8 years left, I’d like to ride it out, however my wife would like to move in the next several years. We could pay it off in full now if we wanted, however, maybe it would be wise to keep house and rent instead? Would hate to loose this low fixed rate. Thoughts?
Debt prepayment is guaranteed. Getting a return on capital is not. Why do people always fail to mention this?
So true. For instance we have a condo that has a fixed rate of 4.875%. We only owe ~$25k, so we can’t refinance. Instead, by paying it off early, we are getting a guaranteed return of 4.875%. Of course there are interest deductions that we will loose, but that is only $1,300 a year anymore. Sam, am I wrong for paying this off early? The payment is $225 a month. I am paying $600 instead. It will be paid off in 4 years instead of 12 years.
That’s just crazy talk! It’s never good to owe money.
Are 5 year ARMs available for below 2.5% anywhere? I haven’t looked extensively (just looking on Bankrate), but it seems they are over 3%. How does one actually implement this arbitrage? That is, where to find a mortgage rate lower than the 2.5% one can get investing in 1 year treasuries.
No matter what anybody says having one less Bill especially a mortgage payment is not a bad thing I don’t care what the curve is or any of the other Financial bulshit to go along with it if you own your house outright nobody can take it from you as long as you pay your taxes get a grip Financial Samurai
Hi Sam! I took your advice and finally made it out to Cali now from the chilly VA area this winter :) West coast is definitely the best coast. Playing and teaching lots of tennis in San Diego. I am also one that is waiting for the 2020 market correction before buying anything permanent here.. I started by west coast location CaliTennis.com and enjoying Travel much more than staying put. So we’ll see after the European clay court season and the Running of the Bulls :)
I have a very traditional Asian retired mom is still stubbornly refusing to leave the Amazon HQ2 area in DC and she doesn’t believe in the stock market so for her, is it better to just let pay off the little she has left on her single-family cottage so she has peace of mind. What are the major negatives for her paying all her other rental real estate outright early? I feel like she should get an Agent to manage all of it but she has no real desire to “retire” and doesn’t travel.
I personally think she should cash out before the next bubble because DC is a total rat race these days…you did right to leave early. The young professionals are so transient these days there, I meet hardly any native-born locals there anymore. Everyone asks why not stay and take the high paying Amazon tech job offers – because Freedom is not about eating avocado toast.
If you’re down here in SoCal, shoot me a message and we can play some tennis or I can intro you to some of the local regulars at Balboa Park. A friend says Mark Philippoussis lives a few mins away… -JC
How do you reconcile this with FS-DAIR? Does the debt/invest allocation formula change in this environment?
Good question. I say the first step is to try and refinance if you can get a better rate and breakeven in under 24 months, preferable 12 months.
Once you’ve refinanced by focusing on getting the lower rate, then you can implement FS-DAIR. Less debt is better than more debt in general.
And if you can refinance down to say 3% from 4%, then allocating 30% instead of 40% towards debt pay down sounds reasonable.
Thanks – reasonable and makes sense.
Hi Sam,
I’ve read a few posts but am curious — have you shifted away from holding your own investment properties in favor of going into Fundrise exclusively? Curious what you’re up to nowadays (maybe I’ve missed a couple of recent posts).
Thank you for another well executed post you obviously put a lot of time into. I wish I were more financially savvy. I read several blogs but often times still can’t determine exactly what I should do in certain situations.
Here is a question for the readers and Sam if he has time.
I think I can get $300,000 for my house this spring in Louisville KY. I am 8 years into paying off a 15 yr mortgage at 4% I owe $70,000 still. I think I could net $200,000 by selling now.
I have the opportunity to move into my fathers empty house and live basically for free. He is in a nursing home and I would be 60 minutes closer to him to see him more.
My question is should I sell the house or rent it?
I make $150,000 to $170,000 a year in commission sales. I am wondering if the tax benefits would warrant keeping the house and renting it out. I would actually lose about $4,000 to $5,000 a year because the rent income wouldn’t cover all expenses. The only thing that makes this viable is living for free in my father’s house.
I think I’ll have at least 2-3 years of this situation. When my father passes I plan to retire within two years and move out of state.
Another thing to consider is selling now so I don’t have to pay any tax on about $80,000 of gains. If I rent it for 3 or 4 years I would lose some of this benefit.
I realize there are a lot of moving parts here and it may need a more thorough analysis. But if anyone sees an obvious way to go please share your thoughts. Thank you.
When you have such insightful posts like these, what would we do if you wrapped up this blog?
Being in the mortgage lending business is not a good one. There is no prepayment penalty. Therefore, if rates go down customers refinance to the lower rate. The bank doesn’t get the benefit of having lent at a higher rate. The bank is also exposed to rates moving up since they don’t get the advantage rate increases under a fixed rate loan or can only benefit years down the line in a 7 or 10 year ARM.
It feels like a great time to refinance your mortgage vs paying it down given the low interest rates being offered.
I’m glad I’m not alone. We paid off the house well over a decade ago and it feels even better now than it did then! Directionally Sam’s math is unimpeachable but for some of us it is a moot argument because our house represents an insignificant part of our net worth. If the two hundred thousand dollars my paid for house represents ever becomes a meaningful part of my net worth then I’ve got way more serious problems than whether it is in the form of equity or cash.
I’m glad too. This post is for those who still have mortgages and are trying to figure out whether to pay more down or not.
That’s a very brash thing to say
I have never regretted paying off our student loans even though the interest rates were very low. It felt amazing paying them off but five years later I’m still happy with that decision. Yes, in theory our net worth would be slightly higher had we invested the money but having the lower fixed monthly cost has allowed my wife to stay home with our 2 year old.
I assume you currently feel the same way about student loans and mortgages?
I paid off my car loan even when there was a dealer 0.9% offer. I was about to refi at the time and having the right Debt-to-Income ratio made more sense. At college, I had an online IT job and paid my tuition every semester.
The sense of not owing Anyone, Anything is real and achievable with proper money management and saving. To some, being indebted by loans *can* put a mental weight and invisible collar on your neck that can negatively affect what you do for money and why you go to work.
Sam
If not paying off the mortgage completely recasting will decrease your payment/increase your cash flow and allow for both. Most banks allow this (but never tell you) for a small fee. I did not see you address this.
I asked this question as well and did not get a response. Hoping commenters can chime in here as I think this is a viable option and would love to get other thoughts on this.
A excellent and pertinent point. Many people always forget a recast.
My peace of mind never wears off. I’m glad I paid off my house back then.
I agree Ellen. The euphoria is gone but the peace of mind remains.
Great food for thought. The only thing this doesn’t take into account is taxes which is why I am currently paying down (off soon) my mortgage. I already have a high cash balance so all FCF is going to paying down the mortgage as opposed to fixed income investments after the tax change – my equity inflows are remaining the same.
My mortgage used to be effectively 2.275% (3.5% Mtge * (1-.35 effective tax rate)) but now with bigger standard deductions and the SALT cap, I’d have to clear 4.375% for dividends (3.5*(1-.2)) or 5.38% for income (3.5*(1-.35)) with principal risk to equal paying off the mortgage which in today’s yield environment are some high beta investments to get the same return. I had sold fixed income funds to pay off most of my mortgage which I had been arbing pre tax change but didn’t make sense after. I currently think of paying off my mortgage as part of the fixed income portion of my portfolio and will continue to put money back into fixed income investments post paying off the balance later this year.
Thank you, Sam. I’ve been contemplating buying a duplex in Austin for investment. Though Austin properties were hot last two years, it is starting to slow down. There are properties which have been in the market longer than three months now. I also check the neighborhoodscout.com for trends. They also predict a slowdown in most neighborhoods in Austin. Your articles about the inverse curve are really helping me understand the current situation. It helps me strategize my next move.
P.s. You are the reason why I got into rentals. I started reading your blog as a starving student and no property. I finished school and paid off student loans. I bought and sold one property and looking to buy another rental. I OWE you a debt of gratitude dear sir! Thank you.
Hey Sam, great post. When you suggest 30% of investable assets in cash, would you consider that above and beyond the cash reserved in an emergency fund? Also, would investable assets be inclusive of pre and post tax investments? Trying to model this out and wasn’t sure how to account for 401k/529s when summing up “investable assets”. Thanks.
Great post! I have a 30-year 3.75% fixed rate on my mortgage. Do you think I could get a lower rate if i refinanced?
Wells Fargo offered me a 3.375% on 30 year last Friday on the dip. $1M loan in CA.
“Now let’s look at a slightly inverted yield curve on March 22, 2019. Instead of paying a 2.1% premium to borrow for 10 years, you’re getting a 0.01% discount to borrow for 10 years.”
This is why I love your blog! I wouldn’t know this otherwise. :) such good insights here. Thanks Sam! You really do help so many people with your writing.
I owe 320,800 with a 4.125 fixed rate(primary). I still have 25 years left. I also owe 489,800 on a quadplex with a 4.25 fixed rate with 26 years left. Should I leave it alone or what kind of refinancing do you recommend. I plan on staying in my primary for at least another 10 years.
Great post, Sam! I’m a newer reader and have been contemplating buying a house in the San Diego area. After reading this post, I feel that I should maybe wait a little longer before buying and save up more money. If the recession is coming I would assume the housing marketing is going to plunge like it did last time, right? Thanks again for your wisdom!
Spring is always the hot season, and winter is always the cold season for housing. With mortgage rates down and the stock market up so for in 1H2019, the real estate frenzy is back.
See: The Best Time Of The Year To Buy Property
If you’re looking for a primary home, I’d keep on looking throughout the year and use various buying tactics to try and get the best price possible. Here’s another tactic.