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You’ve seen them.
Over and over and over again, so-called personal finance gurus railing against debt. But as I pointed out before, they’re dead wrong (in most cases). That’s why rather than being concerned, I’m actually happy to keep paying 3 mortgages into retirement (2 of which may outlast me)!
Why Paying the Minimum on Mortgages Is Smarter than Aggressively Paying Them Down
If you don’t want to spend 3 minutes reading the full details in the above-linked article, here’s the short of it.
For years, mortgage rates have been only marginally higher than long-term inflation, so your real cost of interest is much lower than it seems. For example, if you have a 3.5%-interest mortgage and inflation runs 2%, your actual cost is under 1.5% (the calculation is: 1.035/1.02 – 1 = 0.0147, or 1.47%).
Instead of paying extra against principal, if you put that money in a high-interest checking account paying 1.75%, like Connexus credit union (not an affiliate link), you’ll come out 0.28% ahead with zero risk.
Invest the extra cash in a low-cost index mutual fund or ETF, and assuming you make the 7%/year long-term real return of the stock market, you’d be 5.5% ahead. Here, of course, you’d be taking on market risk, but over a multi-decade span of most mortgages, that risk is fairly low.
The above gets supercharged if you deduct your mortgage interest, whether because it’s a business expense, or because you itemize deductions. Add in a higher-than-average inflation rate like what we have now, and those numbers get turbo-charged.
Before you trot out those tired arguments about how if you have a mortgage the bank owns your house (no, that only happens if you stop paying), or the risk of foreclosure, you need to think it through a bit.
Tack on an extra monthly payment each year for a decade on a 3.5%-interest 30-year mortgage, and you’ll have cut off just under 2 years from the life of your mortgage. Say you then lose your job and can’t make your mortgage payments, you’ll lose your home.
Had you invested that extra month’s payment instead at 1.75%, you’d have over 14 months’ worth of payments to tide you over until you get back on your financial feet. Had you invested it at the historic stock market average return of 10%, you’d have almost 16 months’ worth of payments.
So exactly which path is riskier?
Making a Nifty 4 Figures from 3 Mortgages in 1 Year with Zero Effort
Unless you’ve been living under a rock for the past several years, you know that mortgage rates have become historically (some would say ridiculously) low.
So much so, that lenders have been scrambling to keep up with the flood of refis.
Although I could afford to pay off our home mortgage, the mortgage on our previous home that’s now being leased out, and the commercial loan we used to buy an office condo, instead I refinanced all 3 loans at rates below the long-term average rate of inflation, and barely above the sub-3% average inflation of the last 30 years.
Then, inflation spiked from that 30-year run to 5.4% year-over-year.
That spike, combined with our low interest rates, resulted in the value of what I owe dropping 2% in the past 12 months, above and beyond the expected reduction due to the principal portion of my payments! Add tax deductions, and that’s a 3% reduction!
To keep private info private, let’s assume a total balance owed of $600k. With that assumption, the combination of low rates, tax deductions, and high inflation would have effectively made me $18,000 this past year!
Ever better, that profit is completely tax-free!
Had I paid an extra $3000 toward principal, that would have cost me nearly $100! Add in the loss of my portfolio’s 40% return in 2020 on that $3000, and I’d have lost nearly $1300!
The Bottom Line
In an article I published 3 years ago (linked above), I made the argument on general principles that prepaying a mortgage is a terrible mistake for most people.
Now, reality proved that not only is the real cost of a mortgage far lower than most people understand, in the right circumstances, like we’re seeing now, mortgages actually make you a tidy profit on the bank’s money.
Given how banks normally set things up, it’s nice to be able to turn the tables on them.
About the Author
My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.