The day I closed on my mortgage refi, back in the summer of 2013, I remember excitedly telling my boss at the time that inflation was going to eat my interest rate.
I was closing on a 15 year mortgage at 2.75% interest. An interest rate that was historically low, I had never seen before, and I suspected we would never see again. And I was right – I rarely find someone with a lower rate than I have.
Currently, I’m working on paying off my mortgage. Sounds like a great goal, right? But more and more often lately I find myself questioning it.
After all, becoming totally, 100% debt free sounds amazing. And I have reasons to want to free up the cash flow that I currently direct towards mortgage repayment.
But I also know that it’s mathematically stupid. And it’s becoming more so every day, as interest rates finally come up from zero. So today I want to take a critical, objective view of my plan to see if it holds up today in 2019.
And then do the real equation, which is Math + Life = Decision.
All About My Mortgage
As mentioned above, we refinanced for the last time in the summer of 2013 into a 15 year mortgage at 2.75%. The old mortgage had been a 30 year at 5.375%, which meant the payment actually didn’t change at all.
It wasn’t our first time refinancing. When we purchased the home in 2006, our interest rate was around 6.5%. We had refinanced once before 2013 to shave over a
After my husbands
So we refinanced into that low, low rate mortgage to be paid within fifteen years. I would be around forty-eight, and my husband fifty-four, if we didn’t pay an extra dime.
That mortgage is now five and a half years old, and the principal has melted off. We now own over half the house, based on the original purchase price of this house. In five more years, we will own over two thirds. And in ten more years, it will be gone.
But I have a different goal. I wanted to enter my forties totally debt free. And so we embarked on the unusual debt payoff strategy of accumulating money in a mortgage payoff fund while paying on the mortgage.
Why Is This Stupid?
Let’s start with a critical look at the current interest rate environment.
Remember, my mortgage is currently at 2.75%. It is not deductible on my taxes as I talked about last week, so my after-tax rate is 2.75%.
I’m currently earning 2% in a federally insured money-market account. It looks like there are accounts paying upwards of 2.25% (as of this writing).
You can earn over 3% in a five year CD.
Heck, iBonds are paying 2.83% right now.
So I was right back then when I said inflation would “eat this interest rate”. It is eating the rate. In one more year, will I be able to get over 3% in a savings account? Will the accounts eventually get back to where they were when I was in my 20’s, at over 5%?
Who knows? But it’s starting to look like we may be financially better off keeping the mortgage, and keeping the payoff fund in an account that earns interest.
But Would We Really Be Better Off?
Unfortunately for me, you can’t just compare (say) a CD paying 3.1% and a mortgage at 2.75%, and declare that the CD will be the better financial choice.
Remember that the savings accounts, money market funds, CD’s and iBonds are all taxable. Meaning that I pay my marginal tax rate on any earnings. This brings my effective rate down. I also pay my lovely state taxes, in addition to federal taxes.
Thank you, tax man, for making my financial life more difficult.
Luckily calculators exist to help with this very problem. I found this one from Calc XML that helps you figure out your after-tax yield. At my tax rates a 3.1% taxable yield is effectively 2.23%.
Less than my mortgage.
In fact, I would have to earn about 4% in a taxable account to hit an effective yield of over 2.75%. That means until risk-free rates hit 4%, I am still mathematically better off paying my mortgage.
Math is only part of the equation – life is the other part. There are several non-mathematical considerations in our lives we just can’t forget.
Four Non-Mathematical Considerations
There are several important pieces to this puzzle we call life, above and beyond the simple math question.
In two and a half years, my oldest son goes to college. College means paying for college. A mortgage payment is going to restrict our available cash flow to fund college payments. We do have money set aside to help pay for his college, but there are also two more kids right behind him. Being mortgage free means more cash available for his and his brother’s college funds.
Debt freedom is important to us. We’ve worked hard, for years, to reach this point. We’ve saved when we could have spent. Eaten at home, hung laundry to dry, had tons of free and frugal fun, and basically lived well below our means to fund our dreams. One of those dreams is total debt freedom.
Owning our home removes a risk. Ever since I sat beside my husband and watched that ventilator breathe for him, knowing there were two young kids at home, the weight of debt has hung heavy on my chest. If we own our home, then no matter what happens (assuming we pay the taxes), it can’t be taken away. We will own it. Losing it to foreclosure is a risk that goes away forever.
The point of all this isn’t to have the most money possible. Sometimes, in the pursuit of efficiency and earning more, more, more…we lose sight of the fact that the point is not to die with the most money mathematically possible. No one will be putting on my tombstone “she paid off a 2.75% mortgage early” with a “LOL” emoji carved next to it.
Then what is the point? The point is to reach the goals that are important to us, and to live a life in alignment with our values and dreams. If those dreams include things like paying off a mortgage, even if it’s not the best financial decision, then that’s great.
Make your dreams come true.
You Do You
Were you in my situation, perhaps you would keep the mortgage forever. You would arbitrage the interest rate, invest everything into penny stocks/real estate/index funds, and keep the mortgage as long as possible.
In fact, you might not have gotten a fifteen year mortgage in the first place. At the time I refinanced, 30 year mortgages were going for 3.5%. You would have gotten that low, low rate and kept the mortgage the full 30 years.
You’re not me, though. I’m pretty sure you didn’t have a husband who lost his job in the Great Recession. Your husband didn’t almost die when you were in your early 30’s. You may not have been supporting your family on a single income for the past four years, because your spouse was at first unable to work, and later decided as a family it just made more sense to have a stay at home parent.
You also perhaps didn’t have a child at 23, and need to worry about sending him to college when you’re forty. Maybe you didn’t start off with a low income, and gradually bring it up over time to the point where you need to expect to bear the full financial burden.
Point being, you’re not me. You don’t have my hopes, dreams, background, or life situation. You’re you. I’m sure you have valid reasons for the decisions you make, in the context of your life.
And I have valid reasons for mine.
I’m still going to pay off that mortgage.
Even if it means I’m mathematically stupid.
What About You?
Have you ever made a decision that mathematically was wrong, but you did it anyway because it aligned with your goals and dreams? Or are you more of a “pure math” decision maker”? Let me know in the comments.