Now that mortgage rates have jumped, it might be time to take a look at how you’re repaying your mortgage.
Put simply, if your mortgage rate is fixed and lower than prevailing rates, it could make sense to slow things down to take advantage of your low rate for longer.
Yes, you have to continue making your full mortgage payment each month to satisfy your credit obligations, but if you’ve been paying extra, it could be time to rethink your strategy.
For a while, I’ve been asking myself why everyone was in such a big rush to pay down their mortgages with rates so low and only expected to go higher.
It’s Been Popular to Pay Mortgages Down Fast Lately
- With mortgage rates so low
- A lot of borrowers have been refinancing into shorter-term mortgages
- But doing so when mortgages are so cheap
- Means your money could be better served elsewhere
Lately, it’s been pretty trendy to knock down those large mortgage balances, with the 15-year fixed gaining in popularity quite a bit post-mortgage crisis.
A lot of folks took advantage of the spread on new 15-year fixed rates versus their old 30-year fixed rates that were in the 5-7% range. This meant they could pay off mortgages in half the amount of time for roughly the same monthly payment.
But now anyone looking to refinance their mortgage will likely be faced with a higher interest rate than what they currently enjoy.
So if you’ve finally got some equity and want to tap some of it, chances are your quoted rate will be higher than your existing one.
This could lead you to go with an ARM to keep payments down. Or if you’re conservative, take a rate slightly higher to play it safe while also increasing liquidity.
Looking at Your Mortgage Rate Like an Investment
- You can view your mortgage rate as your return on investment
- So if you have a rate of 3.5%, you’re earning 3.5% when you pay extra
- If you can earn 6-10% in the stock market instead
- You have to consider the opportunity cost
When you pay extra on your mortgage each month, you’re making an investment at whatever the rate is. If it’s 3.5%, you’re effectively earning 3.5% in interest by paying it off ahead of schedule.
This may make sense with savings rates closer to 1%, and bond yields also dismally low. But everyone expects rates to rise and inflation to rear its ugly head.
In a few years, we might have a situation where savings rates are in the 3% range or higher. If you’ve got a low fixed-rate mortgage you’ve aggressively paid down, you might miss out on that higher return in the future.
That money earning say 2.75% on your 15-year fixed could have been put in an account earning 3% or more, not to mention it’d be available to you at any time for a withdrawal, instead of being tied up in your property.
Now if market rates were lower than what you had, you’d probably want to pay down your mortgage faster or refinance to avoid the extra interest expense.
But if you’ve got a 3.5% 30-year fixed and rates are closer to 4.50%, what’s the rush to get rid of it? Sure, there will always be the people who want to pay off the mortgage as fast as possible and live debt free. Or those close to retirement. And that’s their prerogative.
There are just better and worse times to do that. Factor in inflation and the argument to slow things down gets even better.
The takeaway is that holding onto an interest rate so low it may never return can be a good thing. The banks certainly won’t be pleased if you do, assuming interest rates keep climbing higher.
You’ll be making out like a bandit while they earn less interest than they’d like. It’s kind of like turning the tables on them.
Typically, banks charge higher rates to customers for loans and pay out less interest in checking and savings accounts.
You could find yourself in a situation where your mortgage rate is lower than the savings rate a bank is willing to offer, a situation you’d want to take advantage of for as long as possible.