Paying off a mortgage with a negative real interest rate is a suboptimal financial move. However, that’s exactly what I did in this unusually high inflationary environment. Bad move? Maybe.
My mortgage rate was a 30-year fixed at 4.25% and the latest inflation figure was 9.1%. Therefore, it had a negative real mortgage rate of 4.85% (4.25% – 9.1%). I had the mortgage for 15 years until it was recently paid off.
In general, you want to keep your mortgage with a negative real interest rate for as long as possible because inflation is paying down your mortgage for you. However, sometimes, not every financial decision is about maximizing returns.
If you find yourself wondering whether you should also pay down your mortgage balance with a negative real interest rate, let me share with you the reasons why I did.
Why You May Want To Pay Off Your Negative Real Mortgage Rate
Here are the best reasons why you should consider paying down your mortgage, despite it having a negative real mortgage rate.
1) Uncertain about risk asset returns.
After a banner 2021, it was hard to see another fantastic year for stocks in 2022. Therefore, when I compared a 5% expected return to a 4.25% mortgage rate, getting a guaranteed 4.25% return by paying down debt was relatively attractive.
As the year progressed and stocks declined, my enthusiasm for stocks also faded. But I kept buying on the way down as I usually have done since 1999. After the Fed committed to raising rates aggressively, it felt like risk assets wouldn’t recover until there were definite signs inflation was rolling over. Thankfully, the signs are now here with inflation peaking in July.
Therefore, if you are uncertain about risk asset returns, paying off debt is a relatively better move. The higher the interest rate on the debt, the more attractive it is to pay down.
Always compare your realistic expected returns to your mortgage rate. Sadly, many investment houses are predicting much lower risk asset returns over the next 10 years.
2) Losing money to inflation is better than losing money to asset price declines.
When inflation is high our cash loses purchasing power. As a result, we tend to want to spend our cash sooner to buy goods before they get even more expensive.
However, it is still much better to lose purchasing power due to inflation than actually lose money from an investment that is going down in value. Sure, your cash’s purchasing power might be down 9% from a year ago. But you would rather be down 9% in purchasing power than be down 20% on your investment plus 9% from inflation.
Given my faith in the stock market declined once the Fed started getting aggressive, I logically decided to use my idle cash to pay down debt. This way, the cash was at least being put to good use. I’m following my FS DAIR methodology to paying down debt.
3) Have strong cash flow or receive a large injection of cash.
If you have a high saving rate or suddenly come into a lot of cash, paying down debt is the easiest move to make. The guaranteed return on paying down the debt is the interest rate. Meanwhile, you don’t want to have too much cash sitting around for too long if you still have debt.
Our saving rate is over 50% and I received a large private real estate distribution of $122,423 in July. Therefore, I had excess cash.
I told myself I would invest 20% of the proceeds into the S&P 500 if it got back down below 3,700. As the market rebounded higher, I didn’t want to chase it. Therefore, I used 12.3% of the real estate distribution to pay down my negative real interest rate mortgage instead. If I waited, I could be waiting for a long time (hopefully as the stock market recovers).
In the meantime, I’m contributing more to online private real estate platforms like Fundrise. Since the investment minimum is only $10, I can invest more surgically in heartland single-family homes.
4) In decumulation phase or are heading into retirement.
It’s a good idea to pay off all debt when you no longer can or want to work. Once you pay off your mortgage, you free up cash flow equal to the monthly mortgage payment. Getting rid of a mortgage is one less thing to worry about in retirement. It feels like a burden has been lifted.
When I paid off one of my other mortgages in 2015, I felt lighter. However, the “downside” was that I also felt lazier. I lost some fire to work hard given I had an extra $2,200 a month in cash flow. No matter as having a child in 2017 reignited the flame to grind.
Today, after more than 2.5 years into the pandemic, I’m absolutely exhausted. Writing my book for two years while raising two young children has kicked my ass. I didn’t even want to write this post. But I made a promise to keep going, so I soldiered on!
By paying off this latest mortgage, I free up $2,480 a month in cash flow. Sure, most of the monthly payment went to paying down principal and not interest. That said, having more cash flow is nice in this uncertain environment where I’m burned out. Now the extra cash flow will be used to pay 110% of our monthly unsubsidized health care bill.
5) Negligible remaining mortgage balance.
If your negative real mortgage rate becomes an annoyance or an insignificant amount, you may want to pay it off. If you’re so close to paying it off and have the cash, you might as well do so now to get the monkey off your back.
At the beginning of the year, my negative real interest rate mortgage had a balance of about $50,000. Meanwhile, the vacation property is worth about $550,000. With a loan-to-value ratio of only 9%, the mortgage started feeling like a pest.
Therefore, every month for seven months, we paid down an extra $5,000 in principal on average. With ~$15,000 left, we decided to just pay it off after getting our latest private real estate fund distribution. And you know what? It feels damn good to get rid of this loan.
We have a complicated net worth, so the less we have to deal with the better. You’ll appreciate the joy of simplicity if you ever set up a revocable trust, write a will, or create a death file.
The feeling of paying off a mortgage is similar to the feeling of getting rid of a troublesome rental property. Joy. You feel like you have more capacity to focus on better things.
6) If mortgage rates and inflation rates are going lower.
The final reason why you may want to pay down your negative real interest rate mortgage is if mortgage rates and inflation are going lower. If rates are going lower, your existing mortgage rate becomes relatively more expensive. Therefore, you would either want to pay down extra principal or refinance to a lower-rate mortgage.
Check online for the latest mortgage rates. The more lenders compete for your business, the better.
However, in 2022, mortgage rates zoomed higher by about 2.5% before falling in 4Q 2022. Higher mortgage rates and inflation makes my existing 4.25% more attractive to keep. After all, the average 30-year fixed rate mortgage reached a high of about 7% according to Freddie Mac.
Despite having a relatively more attractive mortgage, I still paid it off because the balance was small compared to the value of the property. I just wanted the pesky burden to go away so I could focus making money elsewhere. If my mortgage amount was in the hundreds of thousands of dollars, I probably would have kept it.
The 4.25% mortgage I just paid off was also my highest mortgage rate out of three mortgages. The combination of highest mortgage rate and lowest balance made paying it off an easier decision.
Not Paying Off My Primary Residence Negative Real Mortgage Rate
I will gladly not pay down my existing primary residence mortgage with a 2.125% mortgage rate. It is a 7/1 ARM that can reset to at most 4.125% in 2027. Paying off a negative real mortgage rate of about 6% is just way too much. A 2.125% mortgage rate feels like free money in this environment.
By 2027, when the ARM is set to reset, there’s a 60% chance I might buy another “forever home.” If I need funds, I will end up selling my existing residence, thereby paying off the principal mortgage in full anyway.
Finally, if you plan to pay down your negative real rate mortgage, please beware of some mortgage payoff procedures. Paying off the exact balance can be tricky. It’s better to overpay a little and get a refund.
Most importantly, confirm the liens are removed with the title company and the bank. You can do so by requesting a reconveyance letter from the mortgage holder.
Although paying off a negative real mortgage rate is a suboptimal financial move from a returns perspective, it felt right for me. The feeling of having one less mortgage more than outweighs having a mortgage balance that’s getting inflated away.
Now I can invest my excess cash flow in 100% passive real estate opportunities through Fundrise, my favorite investment platform. at my age, I’m all about simplicity and making as much 100% passive income as possible.
Questions And Action Items
Readers, have you been paying down your mortgage with a negative real mortgage rate in this high inflationary environment? Why or why not?
After paying off three mortgages, I’ve come to realize I like to pay mortgages off in about 10-15 years. Waiting for 30 years feels too long. Therefore, getting a 7/1 or 10/1 ARM is more optimal given the interest rate is lower. ARMs also motivate me to pay down extra principal.
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charlie @ doginvestor.com says
Since there is no free lunch, who sits on the other side of a fixed loan that homeowners have borrowed at 2% now that the market rates are far higher? I’m not in the US, our market has only floating rate loans, so am trying to understand where the risk is in the model of fixed loans.
The banks lend out at 2% fixed, but what do they do on their side to hedge since someone is sitting earning 2% fixed coupons but floating rates are far higher – is the Fed the holder or banks themselves using depositers funds? If depositers can get higher yields elsewhere, will they pull deposits? Just feels like there is a big asset-liability mismatch and trying to figure out where? Thanks Charlie
Person, who prefer hard cash, sits on the other side of a fixed loan.
1 payment = real payment.
360 payment= CANDY BAR.
N Chu says
I’d add reason #7 to your list: reducing financial risk. Trouble likes company: one’s most likely to lose a job when the economy & financial markets are down. That is exactly the time when having low cash outflow is most valuable, and a paid-off primary home is a big part of that.
Dunning freaking kruger says
Yes. We are paying off our 10 yr FRM @ 2.45. Started last year. We should have it paid off in the next 36 months. We will be mid 50s with a paid off primary. Also invest 12,500 monthly. Two substantial pensions. 0 debt except property tax and insurance.
KISS principle. Simplicity changes decision making. More effective decisions. This is progress.
Money Ronin says
I’ve been reading your site since 2013 when I semi-retired. I cringe every time you write about paying off your mortgage early. This is one area where we disagree. Assuming you are holding a low interest mortgage (<5%) with 3+ years on it, you are likely going to do better investing it over the that period of time. Give me 10 years and 3% money and it's a no brainer unless you are very unlucky with your timing. Paying off the mortgage especially doesn't make sense where real estate appreciates steadily (sometimes dramatically) over the long run; you are just locking up an ever increasing equity stake and killing your return on equity.
I think even you admit the numbers don't support paying off one's mortgage and it comes down to "peace of mind". If "peace of mind" were the primary driver for financial decisions, maybe we should put all our money in US Treasury bonds. You certainly don't come off as a risk averse investor, so this mortgage pay off decision always strikes me as an anomaly.
I think a more interesting debt discussion would encompass guidance driven by interest rate, # of years the rate is locked, debt to asset ratios for the property, debt to total asset ratio for the borrower, tax deductibility of mortgage interest, and potential long-term return if the money were invested in something other than the mortgage. Debt is a complex financial tool that is often less understood and less discussed than equities. Maybe you can create one of your tables where at a certain age, your ideal debt to asset ratio should be X%.
Since 2013, my mortgage debt has exploded given my foray into real estate investing. I'm living what I preach.
Financial Samurai says
Sounds good mate. And congrats on an explosion in mortgage debt!
Not sure if you read the specifics of this post based on your assumptions. But all good. I wouldn’t let things like this make you cringe.
Logically speaking, it probably doesn’t make a ton of sense to consider paying off my mortgage soon. But I rather would like to. I didn’t need it when I got it, either, it’s just $250K but a 10/1 ARM and can rise to 9.99% or something. It’s 3 years into it. I needed a large amount of cash for a career investment (movie) so I’m glad I kept the cash laying around. But the mortgage is not even 5% of my monthly income, which is probably why it just feels obnoxious to me. I like the psychological idea of owning the house free and clear and now the thing is $1.4M so it’s a minuscule portion of the value. At the same time, the 2.85% rate or whatever it is, something like that, is so low that I know it’s a good deal.
I just want to transition into more of a situation where my monthly expenses are tiny despite a huge income so that I never feel even somewhat obligated to be concerned about money. I have always liked the idea of extremely low guaranteed expenses (something like eating out, or home improvement projects can be cut in tough times, but mortgages, insurance, taxes, etc. cannot).
This is really interesting. So would you say in current times would it be better to payoff mortgages on rental property and secure more cash flow or would it be times to jump on oportunity and get even more debt to get another property?
(by the way, in my country mortgages rates are around 9-10%. rates of 5% let alone 2 or 3% do not exist here)
Financial Samurai says
It’s tough to say without knowing your situation. But I am personally going to look for bargains over the next 12 months as I’m sure some people overextended during the mania in 2021.
Michael Collins-Frias says
My situation a bit different than most.
My current mortgage $515,565 balance with rate of 2.25% fixed rate payment of $2,350 monthly.
My retirement income is $5,600 monthly.
Not including annuities.
Annuity funded based upon inflationary increases.
I am retired 53, with VA rating of 100% and have zero expectations of finding employment — retired.
6 degrees but retired.
Annuity funds untouched is about $1.6 m with monthly amount if I took distribution.
I have never withdrawn funds.
My total credit card debts $13,500
My background includes BBA Accountancy, rather be working than retired.
I’m my opinion review own financials then if adjustable rate mortgage works for situation then good, but be wary of rate increases coming. Federal reserve rates are moving upward. Bank rates are competitive toward keeping customers but federal reserve will raise rates again until inflationary pressures reduce. This is due in part of board policy required upon annual reports requirement of a 2.5 basis point minimum per trust requirement.
Additional upward amount of 1 basis point for operational expenses upon access of trust funds held & managed.
Expect banks to pay 3.5% minimum from now on.
Adjustable rate minimum will possibly go up to around 7% minimum probably higher.
Expect the unexpected.
I am retired US Treasury.
Protect own assets. None else will.
We’ve got a 10 year ARM at 2.125% on a vacation property. We’re a little less than a year in on it and have been applying your debt paydown vs. investment strategy to it. I think I’m going to keep doing that at least until I get the balance down to the tax deductible amount at which point I might do a recast.
C M Cal says
Great post. Always an ongoing question and so helpful to have some tools/framing that one can adapt to their circumstances.
I continue to struggle with paying off mortgages early, all of it psychological. We have two smallish mortgages left ($90K on a rental, $210 on a primary residence; both we have enough cash to pay off) and one medium-sized one. Two things keep coming back — the comfort of a high cash cushion/emergency fund, plus this nagging desire to keep all options (whether moving at a future date or new investments) open through liquidity. I think for individuals/families who aren’t rooted anywhere or committed to certain plans it feels good to always have options. It’s been a high price to pay to keep all this cash, though I don’t think I would have had the courage to early retire without this huge cushion to ensure I can ride out the first two years of living only on passive income.
Simple Money Man says
“However, it is still much better to lose purchasing power due to inflation than actually lose money from an investment that is going down in value”
Can you help me understand this? If I’m buying good and services with less purchasing power I figured I should limit that to necessities. And if I am continuing to invest as investments overall are declining, I’m buying at lower prices (which for a long-term growth investor could be good).
Saw your interview by the way, you’re no longer Wilson from Home Improvement! :-)
Financial Samurai says
Sure. Let’s say you have $100,000 in cash in your drawer. Inflation is 9% all year and you don’t spend your cash. You still have $100,000 in cash, even though it can only buy ~$91,000 worth of goods.
Conversely, lets say you bought $100,000 in a stock that goes down 40%. Your stock is worth $60,000. Which would you rather have?
Currently have 44 months left on a 2.75% (about 108K). Can’t justify paying off early at that rate but it is starting to feel weird riding it out with the balance so low.
Tom jones says
What are your thoughts on buying a property with plans to airbnb. This way you can use it and rent it out…
K. Sawyer says
Make sure that you are prepared for the sheer amount of time involved in running what is effectively a small hotel. Booking, cleaning, maintenance from rowdy guests, bookkeeping, insurance, etc. There’s a reason hotels are still in business at this point, there’s certain economies of scale that you’ll be fighting against. That’s all after you try to find an optimal location that will make or break your returns for the entire time you run it.
There are some perks to being a traditional landlord in that you only have one tenant or family per unit, as opposed to dealing with a steady stream of guests. If you screen well, you can have a tenant who’ll be there for a few years. Figure out what your risk tolerance is like and run from there.
I did this. It’s a lot of work. Might convert it To a furnished rental. If you can find a good and reliable cleaning team, gardener, or even co host, it def makes things easier.
A couple of years back I had about $60k left on my mortgage at 2.4%. My parents had cash just sitting an a bank account making zero interest. So they loaned me the moeny and I paid it off and the money I otherwise would have made to the mortgage I’m sending back to them. So I think every situtaion is different.
That was my last outstanding debt and everything I have is paid off. its a nice feeling not having any debt other than the monthly credit card bills. Some people feel better that way others rather squeek out more money and that’s fine too.
Financial Samurai says
Nice parents! Did you just ask them for the money?
My parents are in the decumulation phase. But I feel uncomfortable whenever they give me any money. But my mother insists to help the grandkids with their education.
I’ve been managing their money and doing their taxes. They basically only have cash sitting in an account with no investments. I wanted to try and invest some for them, but they are in their 70’s and don’t want to mess with the market. So I helped them at least put their money in a online savings account which is better than at the local bank. I just asked them if I could borrow some as they weren’t using it. I already paid them back, actually faster than if I just kept making the monthly mortgage payments. I don’t like owing anyone money even family who didn’t give me a time frame to pay back.
My parents philosophy is that they rather help me when I need it then just leave me a bunch of money when they pass and I may not need it then.
Financial Samurai says
Sounds good. A good philosophy to help our children while parents are still alive!
You might enjoy these posts: Two Retirement Philosophies
Thanks for this post – as usual, super insightful and helpful to understand your train of thought.
One question for you – do you ever consider return on equity in these sorts of decisions and at this stage of your own journey? It’s something I’ve been increasingly focused on considered where I’m at (~60% of the way to fire, 36, married and 3 kids). Or, to the contrary, are you mainly prioritizing for having more time / quality of life at this point? Has your thought process on this changed over time?
Thanks again, as always.
Financial Samurai says
I still always do. The number one hurdle I compare any investment to is the 10 year bond yield, or the risk free rate return. It is currently at about 2.65% after being as high as 3.48%. So long as my mortgage rate is above the risk free rate of return, I have a propensity to pay it down.
From my primary residence mortgage at 2.125%, I have no desire to pay down extra principal at all.
Sam, Given the bond yield curve is inverted, does it make more sense to look at the highest yielding term—currently the 1 year bond—in these scenarios? It’s about 3.27 right now.
This is certainly an interesting concept I need to explore further. Inflation is giving all sorts of new lenses to assess our debt situations.
We’re happy to have all student loan and mortgage debt paid off at this stage of our journey. We’ll likely ride out our 5-1 ARM on a combined mortgage for our four local rentals – 3.85% with 3 years until the ARM is up.
Thanks Sam. Timely post. We paid off our home in the summer of 2014 with a 30yr fixed rate of 3.375%. We have been in our home since 2006 and plan to stay. We purchased it for $435K and the recent market comps around us are pushing the value around $750K. We paid it off for a couple of reasons. (1) We didn’t want the debt burden as this was only debt because it made us feel good. (2) We were planning early retirement in 2020. Fast forward to today…I have not retired…thought I would ride out the Pandemic since we were working 100% remote. I continue to ride the OMY train … but that train will end no later than 12/31/24, if not sooner depending on my “give a sh*t” meter. We do have ~4 years of “non-discretionary” expenses in cash or ~2.5 years of all spending (based on 5 year historical trend). We also have a HELOC at 80% of home value based on an appraisal completed 2 years ago for ~$480K, with a current rate of 6% and obviously going up with every funds rate increase. Over the past 4 years we have been upgrading our home, using available cash (deck/screen porch, HVAC, Paint, Basement Pub, Woodshop, new roof/gutters). We are now ready to upgrade the kitchen and living room. My question, use cash or HELOC? I assume cash since inflation is eating it up … but if HELOC is at 6% and inflation is running at ~9% and I can deduct on my taxes for home improvements … why not HELOC? Thoughts?
Financial Samurai says
My thoughts are you must be much wealthier today than in 2020! Do you feel like you are experiencing the one more your syndrome?
I’m against taking out a HELOC in general. The rates are higher than a mortgage rate you could get, and it’s just taking on more debt when you’re supposed to be paying down debt in retirement.
But, it really is up to you!
If you can go deeper, what is really stopping you from breaking free?
I’m in an odd situation, in that my only mortgage is < $60,000, but the interest rate is only 2.875%. Seems to be in the middle of the situations you mention above, so I just pay double the normal payment and plan to nuke it in < two years.
Financial Samurai says
Seems like a good solution. What is the loan to value ratio? What is the value of your property?
A lot depends on your cash flow and how much the loan bugs you or not.
Loan to value < 10% as the house has inflated tremendously since we bought it. I don't like debt, but my wife views it as "the silent killer," so she'd like to get rid of it.
Jonathan Y. says
Such a timely post for me.
We are 5 years into a 15 year 3% mortgage with $225K remaining in balance.
We have the cash to pay all that off at this moment.
But I also recently saw that there are 10-year CDs at 4.10%. Sounds like I can get the mortgage for free.
Would you get the CD instead of paying off the mortgage?
Financial Samurai says
After tax, it seems almost like a wash. I don’t know your total cash balance, net worth, or loan to value ratio. But if you share, I will have better thoughts.
Scott H says
Thank you, Sam, for continued writing of your blog and newsletter! I certainly look forward to reading your articles. I’m enjoying reading your book as well. I’m purposely holding cash at this moment for two big upcoming costs. Completion of a pool-~$30,000-and daughters wedding-~$20,000. After the daughter’s wedding, I’ll probably add about $250 per month to paying my 3.50% mortgage-balance ~$290,000.
Financial Samurai says
Congrats on your daughter’s wedding! I will be both happy and sad to see my daughter get married. I hope to live a life true to myself over the next 25-30 years, before that day might happen.
Are the other parents contributing to the wedding as well?
Scott H says
Not so far. But, my wife and I have been planning for this for a while, and gave my daughter a budget of $25,000 from us. Anything more, and she has to find other financing options. She and her fiancé both have well paying jobs should they need more.
Does the analysis change at all for rental property?
Considering turning my current primary into a rental in the next 6-12 months, but still debating if it’s worth the hassle for a couple hundred bucks a month in income plus the principal paydown.
Financial Samurai says
All expenses related to your rental property are deductible. So the urgency to pay down a negative real interest mortgage is less.
While some owners with very large Mortgages can only deduct a certain amount before the phaseout starts.
Alex Smith says
Sam – Congratulations on paying off your mortgage. While I understand why you did it an interesting option for someone in a similar position would have been to do a mortgage recast. I have done one before, very simple process. Any thoughts on using that tool?
Financial Samurai says
Sure. Here https://www.financialsamurai.com/the-benefits-of-recasting-over-refinancing-a-mortgage/
Ms. Conviviality says
Coincidentally, I was asking myself just yesterday whether it would make sense to throw more money towards the loan on a rental property since cash is accumulating because we are uncertain with what to do with our income. We have 12 months of expenses covered so having a larger reserve isn’t necessary. It’s been over a decade since our primary home has been mortgage free and that’s nice but I don’t think I would get as much joy out of having another mortgage free property when considering the opportunity cost of not having cash to invest should a good deal come along.
Debt Savvy Dad says
This post is a good example of how financial decisions are dependent on someone’s particular circumstances. As someone who is more than a decade younger and not retiring for at least 15 years, a high balance on my principal residence (and only mortgage), a plan to work for well over a decade longer, and looking forward to more children, I have a completely different set of circumstances.
I’ll be taking a mental note of this post for when I’m *hopefully* in a similar position 15 years from now.
The thing I love about your thought process is that Risk is always added into the equation, which I think is necessary for all financial decisions but so often neglected. Without risk, we’d all be pulling cash advances to buy crypto.
I appreciate you keeping up with the content, but if you need a break, I’d love to see some excerpts from BTNT.
Risk consideration is important.
Kevin, I would just buy a hard copy of the book if you are curious and support Sam. You’ll gain much more value than the cost of the book anyway.
I will. I’ve got a couple of other books in the queue to get through first. But some authors will post quips to whet people’s appetite and drive book sales that way.
Did you read it? What did you think?
I did. It was great and I left a nice review. Really good discussion on the big dilemmas in life. Goes very deep into each subject, rather than scratch the surface to address the masses.
Remind me to never write a book. If it takes this much convincing to get a regular reader and commenter to buy a book, it must be almost impossible to get a regular person to buy a book!
Much better ways to make a living. :)
Paul Lutes says
> “It’s a good idea to pay off all debt when you no longer can or want to work. ”
For someone who is fully retired and has enough cash to buy a house (and enough extra to cover repairs/renovations), would you recommend that they pay cash, or would you still finance the purchase?
Love the blog. Just bought your book :) I’m in a position many people who live in expensive coastal cities are. Have you ever written an article on this?
I’m almost 38 years old, Net worth around 1 million, but live in NYC (Brooklyn). We’re planning on 1-2 kids, and to even get a 2 BR condo in an area with a good school district is 800-1.2 mil. What are your suggestions for people in my situation, who don’t want to throw away 50%+ of their net worth on an apartment but also don’t want to move to the suburbs or an up and coming neighborhood.
Thanks. Keep up the great work.