When to pay off mortgage in low-rate environment?

One of my neighbors just decided to pay off their home. While the usual reason is the feel good full ownership of your primary residence, here their main reason was that they had money sitting around (beyond their emergency funds) that they could not invest with better guaranteed returns.

They were 6-yrs away from paying it off normally at 2.75% APR. Since they were not itemizing their mortgage interest, assuming their marginal rate at 22-24%, that looked to me fairly equivalent to a 3.4% 6-yr CD that you simply cannot break.

I’m guessing their balance was too low to make refinance an easy alternative considering their 2.75% rate. So that made me wonder at which point in very low rate environment, does it make sense to do what they did? I felt like I was missing something but I could not figure out what. Any ideas?

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Never.

I’m doing a cash out refi on my properties to get a bunch of equity out. I’d rather have cash in the bank at 1% (or even 0) and pay the meager 2.75-3.5 % interest now while waiting for an opportunity to invest. A fully paid off investment property that doesn’t even meet the 1% rule (more like 0.5% in CA) can generate a cash-on-cash return > 4%.

Edit: fixed typo (0.05% -> 0.5%)

They don’t look the type to want to bother with rental properties though. With their 4 kids, they seem to have tons on their plates as it is.

But that was my only counter-argument too. Basically having cash for opportunities, especially since they are talking about buying another property in their preferred future retirement area within a few years. Nobody will lend you for a downpayment.

What’s their plan for the extra cash that accumulates every month now that used to go toward the mortgage?

So essentially,
high mortgage rates ->pay off mortgage,
low mortgage rates ->pay off mortgage,
medium mortgage rates -> keep the mortgage ??

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Very good question. I don’t know what they intend to do with the cashflow. I assume it’ll just end up in some savings. The money to pay off the mortgage is currently in savings earning less than 1% (think they said Discover). It may be a way to punt until savings rates recover somewhat. They should basically get back their available money in the 6 years that it would have taken to pay off their house but I guess they get better return in the meantime.

In a few years, their mortgage will be paid off anyways. And after paying it off now, they’ll replenish the cash via saving what would’ve been the monthly mortgage payment.

They can always open a HELOC on the paid off house, to provide a source of quick funding should a hot opportunity present itself in the meantime.

True, I’m not sure how HELOC rate would compare to their previous mortgage rate but currently it’d not be too different.

I’m guessing that their calculation is rather simple: keep mortgage at low rate but have a ton of cash earning nothing and that they don’t know what to do with VS. pay mortgage balance effectively earning a bit more on that pile of cash and feel good about owning their property in full.

The question really depends on the individual and the situation.

Key word there might be “guaranteed”

If they are that risk averse and actually want truely guaranteed money then theres no better options for that that I know of right now. 5yr CDs pay like 1.5%

Also you have to consider what they actually would have done with the money otherwise. If they really would have done nothing but let it sit in savings at 0.1% then they’re better off saving the 2.x% interest
They also might not have owed a ton so maybe it wasn’t a big deal either way.

This might work best for them.

My dad is super risk averse and mostly just sits on his cash in savings making next to nothing for interest. He barely trusts banks much less the stock market. If he had a mortgage it would make sense to pay it off vs his other normal behaviors.

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I wasn’t suggesting it for them, only providing an example of what anyone (with a big enough pile of cash) could do right now to get > 4%. This > 4% CoCR includes expenses for a property manager in a very expensive market. The return should be even better for self-managed or in a cheaper market.

Yeah, but recovering savings rates also imply rising mortgage rates. The magic move is to cash out refi at a low fixed rate just before all rates start going up :slight_smile:.

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Wasn’t that also true when they took out the mortgage? And also true for the past couple of years? Why now? I think they got spooked that their guaranteed rate fell from 1% to 0.5%, and cannot imagine that it will ever change within the next 6 years, even though it has only been 3 months. Inflation is probably the biggest risk.

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Good point. No question the drop in fixed interest rates has been pretty rapid and historic in magnitude. My guess is that previously they could find fixed CDs that were paying out more than their mortgage interest but that looks impossible in the current outlook. And they had asked their lender for a refi but apparently rate was unattractive on such a small loan (<$100k).

A very good point is that 6 yr term is pretty long to effectively lock 3.4% returns and nobody has a crystal ball on how rates and inflation will go. Fed certainly look to keep inflation low whatever it takes. Things could recover or we could be heading into a Japan-like stagflation for a long while. I cannot advise them either way on this.

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Should the decision depend on the stage of life one is in? When in accumulation phase, you have sources of increasing income in foreseeable future. When close to retirement, you want to reduce complexity and expenses because income is about to dry up

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We kept a lot of cash out of the stock market as it grew over the last few years. Did not buy any rentals also because numbers did not meet our comfort points.

Markets keep going up with every downfall turning into a V shaped recovery because of the historically unprecedented support from Fed

We reduced our debt footprint on the primary home to reduce the overall risk in the system. Mortgage + cash flow is going into stocks.(wealthfront)

Who knows when the music will stop and what will cause it but it is not usual for any country to be able to issue unlimited debt

I think that only makes sense mathematically if you have no assets (as opposed to one’s physical and psychological needs and wants to simplify their life and do as little “work” or thinking as possible). If you have assets like home equity, then deploying those assets in the way I described would produce income that more than covers related expenses – a positive cash flow. And you’d better do the cashout refi before your income drops below what’s required to qualify.

No argument against accumulating all the time. It is just a question of priorities. I do like your idea of constant tapping of equity to grow the rental empire and I did the cash out refis early on but now I enjoy positive cash flow more even though taxes take a bite. I like to think that I can reduce rent at any time for right tenants without going negative. That obviously means that capital could be employed more efficiently

Also taking cash out refi on investment property at 4.5% after paying few thousand dollars in costs, and putting that money in 0.75% savings account waiting for right property seems to be just too risky and a prelude to bad decisions. But nothing ventured nothing gained :grinning:

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Sure. That’s why I’m doing 3.5% with $0 costs (deal may no longer exist due to an extra fee imposed last week). Where I live I can’t easily get more than 4% return, so that’s my breakeven now. If I was investing in the south somewhere, the returns can be 10-20% and I’d do the 4.5% or even more, and with fees (I generally prefer to refi without paying anything out of pocket in exchange for a slightly higher rate, but some recent new rules have made this more difficult).

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fwiw I went the first-position HELOC route and I’m currently paying 3.25%.

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Where can we get heloc on a rental at 3.5%? I would love to get this for some of the rentals

A cashout refi, not a HELOC. Probably nowhere now, but I got it at my friendly neighborhood broker (originally found on Zillow). He gave me a rate & price that was even lower than advertised. Probably because I was a well-qualified repeat customer refi’ing multiple properties, so I’m guessing he’s giving up part of his profit. I’m sure it also depends on the loan amounts (i.e., there’s more profit for the broker in a $400K loan than in a $150K loan, since they do the same amount of work for both but get paid a percentage of the originated amount).

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