Pay Down the Mortgage or Invest: Part II – Rising Interest Rates

Now that the year of 2016 is wrapping up and we are only around 4-5 weeks away until we ring in the new year, I have been deeply thinking about my extra-mortgage payment paydown strategy.  Mortgage interest rates have been sky rocketing since the election, another element to showcase the rollercoaster ride that we are truly on.  This has caused me to potentially make a tweak or two to my strategy that I have had in play for the last few years.  Let’s see what I mean!

pay down the mortgage or invest

Paying down Mortgage Part II Intro

This article and thought, was even further prompted by Financial Samurai’s Mortgage Paydown Strategy, where he has laid out the strategies and his objectives.  That article then fired me up to set a conclusion on what I want to do with my extra mortgage payments.  I’ve been paying an extra $500 every quarter for the last 2 years.  My mortgage amount for principal and interest is $447.  Therefore, the extra $2K per year was actually 4.47 extra payments per year!  I’ve made a couple one-time extra payments in the earlier years of my mortgage history (began in September 2011), so I’ve made around 11-12 full extra payments on the bad boy.  

All of these pay-downs, however, have occurred at a time where interest rates were tremendously declining (tremendously is used heavily here), from my mortgage rate of 4.375% down to the mid-to-low 3 percent range.  Instead of re-financing during that time, I simply made extra payments on the mortgage to reduce the payment life.  To me, at a time when the stock market was crushing it, it made sense to try to apply extra cash every quarter at the mortgage, to have a double-attack occurring.  However, as you can see from the snipped picture below on mortgage rates, they have started to jump back up post-election and it isn’t showing any sign of slowing down. 

mortgage-rate-for-article

As you can see, since only August – the rates have increased more than 54 bps!  That is a 15% increase in interest rates in just a short period of time.  This has a tremendous impact on the strength of your mortgage rate that you currently have, which assuming you’ve purchased your house in the last few years, and/or refinanced recently – are in a fairly strong position.  Again, my rate is 4.375%, so still higher than what the average 30 year is showing (credit to bankrate.com).  Therefore, mine is still higher, but the trend is pointing that it’ll break through my rate in no time.

The other item I have been considering, which I don’t want to predict what will happen, but is the Federal Reserve.  They have hinted numerous times and it is expected that another 25bp increase will occur.  What will happen to mortgage interest rates?  More than likely, will rise.  What does that mean?  Well – from a pure math/number stand point, if the average rates outstanding in the market are showing a higher rate than yours, then I should reduce my pay-down faster strategy, simply because there would be other opportunities out there that would be more advantageous with my money.  However, as FS also stated, a lot has to do with personal preference and what value it brings to your life in how you want to pay-down and get rid of debt.  The battle ALWAYS continues with asking the question – should you paydown the mortgage or invest?

Here is the kicker, though.  I hate debt.  I want my cash flow opened up, hands down.  I hate it just as much as the next person and dammit – if I could just write a check for the remaining amount of the mortgage I would, however, I love investing more than hating my debt : )  However, I’ll always make some form of extra payment, I concluded, as it just feels better ultimately and it’s reassuring knowing that in my lower 40’s I’ll have this mortgage out the door.  I am sure during those later years, I’ll have tuition payments to make for children, potentially, and/or will allow cash to be heavily fueled into other investment, further reducing the financial freedom clock!  This falls in line with Bert’s recent Student Loan attack mode strategy, where him and his wife are determined to just kick some ass over that.  I am sure they would still want to do the same with a mortgage in their name.  Hell, we all know that every dollar counts in this game!

My Adjusted Extra Mortgage Payment plan

With rates starting to jump back up and pending a federal reserve increase, for 2017 I plan on reducing my extra payment amounts from $500 to $250 per quarter.  This starts January 2017 and can be adjusted if all of a sudden mortgage rates stay where they are or decline.

With me reducing down to $250 per quarter, this equates out to a total of $1,000 per year.  This still is approximately 2.25 extra payments per year, which keeps me on track to pay down the mortgage and balance out the finances a little bit more.  My expected mortgage payoff date was August 2030 and reducing down from $500/quarter to $250/quarter, extends this out to October 2033.  The increase in interest is approximately $6,300 over the life starting January 2017 through the new maturity date or an extra few hundred dollars per year.  

What do YOU the readers think of this?  Are you changing your extra payment strategy?  What would you do in this situation?  Obviously, very lucky that i have extra funds by saving my money to make these extra payments.  Please feel free to chime in, as I can’t wait to read and see different perspectives.  Heck, your perspectives may even help sway what I do.  I appreciate you for stopping by, reading and commenting!  Happy investing, keep saving and… screw debt that doesn’t put money into your pocket.

-Lanny

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30 thoughts on “Pay Down the Mortgage or Invest: Part II – Rising Interest Rates

  1. Just a question, where are you investing the reduction? Honestly raising mortgage rates themselves should not drive your decision. Instead look at alternatives to paying off your mortgage. At 4.375 your cost is probably low to mid 3s depending on your tax rate. So for maximization you should invest in only those items with a higher return then your mortgage. What earns greater then 3 percent that you feel is stable. Myself, I’m front end loading my prepay, dropping significant extra cash this month into the mortgage so that if/when rates do adjust up I can stop mortgage prepay having hit my desired payoff date. This is because new investments right this second earn less then my mortgage but I don’t expect this to continue. This money is allocated to a low risk allocation already so it’s bonds versus mortgage not bonds to stocks.

    • Full Time Finance –

      Thank you for stopping by and dropping a comment. Definitely building capital to either invest into dividend stocks that are undervalued (becoming tougher) or building capital for other investment purposes.

      I agree on the tax-effected mortgage rate – in the mid-to-upper 3’s. Understand your allocation – I have a few dividend stocks I’ve been monitoring that yield between 3.50-5.25%; as well as potential upwards appreciation + dividend growth, which bodes well/typically will be > my cost of capital being used on the mortgage.

      Thoughts on that? So you are front-loading the heck out of the mortgage to hit your preferred payoff date then, eh? Say if you wanted it paid off by 2030 – you are throwing all idle cash at it?

      -Lanny

  2. I always wonder how much difference it will make with paying off vs. investing on the long run. We choose to invest instead of paying off. Our interest rate is set on 3% for the next 13 years. Then we have to refinance. Although I never really calculated the whole effect, this just felt like the thing to do.

    Despite higher interest rates in the future, I don’t think they are the biggest driver. Like FullTimeFinance also mentioned above.

    In terms of reaching financial independence however, I love the idea of reaching independence without having any debt. Meaning we would be truly free after we paid off our total mortgage, which is over 28 years.
    This, for me, would be 1 of the biggest reasons to start paying off early. And get closer to FI in a shorter amount of time.

    • Divnomics –

      Thank you for the comment, loving the feedback. That’s amazing that your rate is at 3%, would kill for that! My after-tax adjusted mortgage rate is in the mid 3 range (pending a few other things, can fluctuate).

      I won’t be financing due to how low my mortgage balance is relative to others (below 77K); therefore, the costs just take so, so long to re-coup.

      I definitely do not want to owe any debts that aren’t in assets that are generating cash flow (i.e. rental properties) when I am financially free, that’s for certain. What’s funny/sad/interesting is that my property taxes are almost neck and neck to my mortgage (P&I) on a monthly basis! That’s the real killer for me.

      I still will be placing extra payments, no doubt to the mortgage, just may be “altering” the schedule a bit. With FTF’s comment below, I could even front-load $1K on January 1, 2017, which will have a better domino effect than 4 quarters at $250 per pop. We’ll see, want to know what the fed does this December, that’s for sure.

      -Lanny

  3. Agree with the above comments, but disagree slightly with your approach. There are too many unknowns to set a firm rule yet. Will – and at what pace – will interest rates rise? What about tax reform and its impact? Trump’s stimulus plan and it’s impact? Any untended consequences with a direct impact to you? Once you find these answers can you form a strategy to best take advantage of any situation.

    • Charlie –

      Thanks for your comment! There are still a few unknowns, nothing official yet with what I’m doing, so I agree there. The tax reform/trump impact definitely will alter plans. However, not sure those will impact 2017, given we are 34 days away, as well. Luckily – I can adjust at any time ; )

      -Lanny

  4. Hey Lanny,

    I’d have thought that with rising interest rates you’d want to INCREASE your payments because the higher the rate on your loan the more you have to pay. Plus rising interest rates will/may see stocks decline, so for the portion that stocks do decline isn’t that (short term) wasted money they could have paid down your mortgage instead?

    Just my $0.02 🙂

    Tristan

    • DDU –

      Thank you very much. Actually, mine is fixed/not adjustable. Right now – with mortgage rates being below mine, it was more advantageous to add something there, but when rates pop up well above where mine is – no need to pay my loan down faster, as my debt is now more valuable, if that makes sense?

      If stocks decline = higher yield on those remember ; )

      -Lanny

  5. I see both sides. On one hand it would seem like stock growth plus dividends would favor a strategy of investing over paying down debt. However, I don’t think anyone would advocate taking out a second mortgage and using the money to buy a bunch of stocks. There is a certain piece of mind that comes with zero debt. I think if it was me my focus would be on investing as opposed to paying down debt.

    • Div Seedling –

      Thank you for your post. Definitely not taking a mortgage out to buy stocks, don’t want my life that complicated haha! May I ask if you know people that have done or are doing it and their argument? I could only see that the rate would be less than they think their performance could be in the market, but how are those payments on a second mortgage being made? Hmm….

      I agree on that peace of mind, planning on being there earlier than what my signed note says : ) Thanks again and talk soon.

      -Lanny

      • Lanny,

        I don’t know anyone that a reckless. My point is that many people talk about the advantage of not paying low interest rate debt and investing instead. However, few would give the advice of going into debt to invest. So clearly there are some advantages to paying down debt quickly, even if you could make a few bucks extra by investing the cash. That said with my wife’s low interest student loan debt. We only have a few years left. We could discharge it tomorrow if we wanted. But at 1.5 percent interest we are in no hurry. Perhaps once it gets under 5k we will just pay it off. But for now we’d rather have the money to invest or put towards a house. We are in a weird situation of not buying because we don’t want to restrict our next job.

        • Seedling –

          Haha, good, good. Yah if your wife’s student loan interest rate is at 1.5% – don’t even add a single exra penny to it : ) Makes sense on not restricting the next job, rent for as long as you’d like and negotiate a low as heck deal if you can. Keep the cash flow rolling into investments/assets that produce more cash flow for you. Nice work DS! Also – how the heck did she get such a low rate??

          -Lanny

  6. Hi Lanny,
    Reducing the over-payment sounds like a reasonable compromise to me.
    My mortgage is at 4.375% too and it looks like I missed the refinancing window as I needed to refinance around 3.5% to make it worthwhile. I don’t pay extra payments into principal but I do put $400 monthly into VWELX (mix of stocks / bonds) as my home payment fund. I figure I’ll pay off the loan early at some point in the future with the proceeds. In the meantime I may as well get as much from the interest tax deduction as I can. Plus the mortgage payment is decreased by inflation over time which helps.

    I can actually afford to pay off the mortgage entirely if I cashed in my Income Fund. But I prefer having cash flow / investment reserves than starting over with no mortgage payment but no assets.

    Best wishes,
    -DL

  7. We are personally a fan of keeping cash-flow requirements low in combination with doing additional payments to the point where the mortgage is about 80% of the value of the house. For us, and using the Dutch mortgage system, this is economically the most interesting option. Once we hit 80%, we stop doing extra payments and will revert to fully invest everything we have into income producing assets. The mortgage will then be paid of in the normal term.
    We keep the cash-flow low by taking shorter term mortgages with lower interest rates, risk here is that we do suffer a bit once the rates increase (but keep in mind that the total amount will be lower due to the extra payments, providing a buffering effect).
    Good luck with making a decision that is right for you. It’s personal finance after all!

    • CF –

      Thank you for the post. That’s funny you made a mention/phrase of personal finance. There truly is that element to it, even when the sheer numbers aren’t totally maximized. The psychology of all of these decisions, ends up being quite amazing, something that can be truly studied by someone. Psychology with debt is just the same, it may be a low as heck rate, but the thought of owing someone something just doesn’t sit well : )

      I’ll be accumulating capital, so that I can deploy the strategy that works. I definitely want to keep making extra towards the balance, but how much will always be the question! I have already chipped away almost 3 years from my extra payments if I stopped doing them today. Would like that to be around 7-10 years of chipping. Talk soon!

      -Lanny

      • Risk aversion is a big thing with a mortgage. It’s someting you have to be able to deal with if you want to strive for maximum yield on your hard earned dollars (i.e. investing vs paying off the mortgage). It’s an easy decision on paper, but emotionally it’s a darn tough one!

          • Thanks 🙂 our original mortgage was a 5.875% 30 yr loan. It felt pretty good refiying for 10 years. I’m super glad about the move.

            At the time, I came across a website that summarized the loan options and fees charged by all the credit unions in our area. We knew we wanted a 10 year loan and so picked the one with the lowest fees. It was a surprisingly smooth, pleasant experience.

  8. I think it can depend on everyone’s situation – interest rate, type of loan, investment costs, etc. We used to make extra principal payments every month. Then 3 years ago we refi’ed the balance of our 30 year loan into a 10-year loan at 3% – shaving off about 10 years of mortgage payments and around $30k in interest that we would have paid otherwise. Unless something changes and we move, we’ll be done with it in just under 7 years. In our situation, my husband and I are more comfortable putting our extra dollars into saving and investing than accelerating the loan.

    • Penny deSaver –

      Yes, if I was in a 10 year loan at 3%, your payments are fairly high as is and the rate/long-term benefit of any extra payments on such a small rate isn’t worth it. Congrats on being aggressive – may I ask what your 30 year loan rate was previously at?

      -Lanny

  9. Lanny – Rising rates may prevent you from refinancing your mortgage, but I don’t think that should impact your mortgage debt reduction strategy. It’s over simplifying the problem and doesn’t factor in risk. If you’re truly debt averse, then you should continue (or increase) your extra principle payments to accelerate towards debt freedom. Once you’re there and mortgage risk is eliminated from your finances, then you can really crank up the saving and investing. It’s not a matter of what interest rate you have vs. the rate the Jones’ have. It’s the burden of your debt obligations on your budget.

    • Polly –

      Thank you for the comment, really appreciate it. Right, I think most of us have a little debt averse, but am trying to look at it from a clearer picture now, to see the long-term impact of investing the difference.

      What’s funny Polly is guess what – the key piece is at least we are doing more, right? We are either investing into “boring” easy to understand assets OR paying down on a debt. We are doing a great job as a community about doing as much as we can!

      Thanks for the input and definitely keeps my mind on – hey, its personal finance and it’s okay if it’s personal to me in adding more to debt pay down!

      -Lanny

      • Ah! Now I get your meaning. The wording in your original post tripped me up.

        Yes, we are doing a great job. Right now I work for my money, but at some point my money will work for me.

  10. Interesting discussion. I think that the extra money should go to where you can generate the highest return. If you can earn over your 4.375% mortgage rate, then I think you should pursue those opportunities. If not, you should pay down the mortgage. At the same time, it’s hard because it’s hard to do that when your first impression is to pay it down and be free!

    I feel the same way about my car loan. However, the decision is much easier for me because the dollar amount is much lower and the interest rate (1.49%) is much lower as well.

    • Andrew –

      Yep, agree on that. Someone mentioned that a rise in interest rates may decline the market and that my appreciate returns may not be promising, but I buy on undervaluation and safe dividend yields : ) And with those yields being higher IF the market drops, even better. Yes, there for sure are other investments that can generate more than that, but am definitely weighing in the fact that I dislike debt that doesn’t do much for me! (I guess you could say this is building equity, roof over my head kinda thing, but no income being generated!!)

      With the car – feel you on that. My used car I bought has a 2.29% rate tied to it. Not huge, by any means and is a very low dollar amount, so not too eager to hurry and pay that off. However, if there are no stocks to buy at some point, then that may happen!!

      -Lanny

  11. I read both you and Financial Samurai’s takes on the subject and I think I’m missing something here.

    Why would rising interest rates compel you to pay off your mortgage slower? If you have a fixed rate, then your rate won’t change at all. If you have an ARM, then wouldn’t the possibility of rising interest rates make you want to pay off your mortgage FASTER?

    I grasp the concept of using any excess cash flow to invest rather than pay down debt when the potential returns exceed the mortgage rate. When the mortgage rate is at record lows is when I’d expect people to do this. When dividends were hitting 4% on reasonably safe stocks and a 30 year fixed was around 3.50%. Not when rates are rising.

    I can slightly understand Financial Samurai doing it since he plans to invest in bonds (though is the 10 year Treasury really going to be higher than his rising ARM?), but don’t you invest in dividend stocks? Interest rates will have effects on certain industries, but not directly in the way that they do bond yields. So why are rising interest rates a signal for you to ease up on your mortgage payments and double down on your investing?

    I am confident that I’m missing a key component of all this here. I’ve read both you and Sam’s take on the matter and I’m just not getting the logic. I had assumed that Sam, someone who preferred ARMs to fixed rates, would have been kicking his principal payments into overdrive.

    Sincerely,
    ARB–Angry Retail Banker

    • ARB!

      Awesome post and I love it! What I mean to say is that my rate will be favorable (Yes it is fixed) in the market place if rates keep the chug upwards. The increase in rates COULD have the shock to the stock market system to push stocks lower (Hell if Johnson & Johnson drop $20 a share and yield over my mortgage rate – I’M ALL OVER IT! haha), however, the market will react in a way that it would like to. What I’ve seen this year is high P/E ratios and low mortgage rates and I was paying down my debt with my cash at $500/quarter. With rising interest rates and an unknown to the stock market, it may provide strong opportunities than paying down the mortgage. Does this help a little? If not, definitely let me know.

      What’s great – is that I haven’t solidified anything from my article and it is a very, very good discussion that I’m starting to see with everyone. A few things have to happen and I may adjust my mortgage pay down strategy, pending those items (Increase in rates further + stock market impact; so 2 things really haha). With one hidden element – the emotion and the bad taste that debt can leave in your mouth.

      What are your thoughts with that? Thanks A R B, appreciate it!

      -Lanny

      • Lanny,

        Love your site and I am constantly inspired by both your and Bert’s articles. Regardless of your ultimate decision regarding your mortgage I have confidence that you are going to succeed in reaching your goals.

        After reading this article, I have to say that I had the same thoughts that ARB had above. I understand that comparing your mortgage rate against a national average may give one the feeling that there debt is “better” or “worse”, but it really comes down to cash flow and expected return on investment. I am struggling to make the connection between national average rates rising and what effect that would have on your unique situation. The largest advantage of a fixed rate mortgage over a ARM is that your bank has the interest rate risk, and not you!

        Since the goal is acquiring solid, dividend paying companies with growing dividends, it may be more prudent to analyze how long it would take a given investment to reach a yield on your original cost (based on average historical dividend raises) that would meet your current mortgage interest rate. That would be an interesting article, at least for other personal finance nerds like myself!….

        And as icing on the proverbial cake, you would be getting a larger mortgage interest deduction on your taxes, for a longer time, while also receiving dividend income at a qualified rate! Seems like a win-win on the tax front. And that’s not even considering an increase in the underlying share price!

        Hopefully this made sense. Keep up the good work and Happy Holidays!

        • John –

          Thank you SO much, that means a great deal to me, thank you, thank you and thank you.

          I agree, I agree, from a pure number stand point it is what use of capital will provide the greatest return. Yes – I could always put a nice spreadsheet together to see how long it takes for a dividend yield investment on pure divvy’s alone to produce it’s own income vs. the saved interest on the loan side of things : ) I think the investment works out everytime, emotion is the tough part, always.

          Of course, of course, agree here as well.. UNLESS your dividend income was so large that you didn’t need any other form of income or use of deductions, eh? Haha, we can go for days about our tax system and the different ways things are treated. Would definitely love to have $35K of dividend income, that’s for damn sure.

          Appreciate it John – what else are you seeing? Whats your favorite piece of article or what’s your favorite topic? Talk soon!

          -Lanny

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