Can mortgage rates get any lower? How long will homebuyers and refinancing homeowners be able to enjoy these low rates? And if you’ve got a low rate, how should you treat it? Mortgage rates have been bouncing off of historical lows for quite sometime. You’ve heard about it in the news… low rates, foreclosure crisis, great deals, and high housing inventories. You’ve saved diligently and have been able to purchase a home with a low mortgage rate (or maybe refinanced your old rate).
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Now that you’ve got your low rate, what do you do with it?
Having a low interest rate mortgage gives you more options than you do if your interest rate is higher. With a higher interest rate you generally want to pay down the mortgage as fast as possible to eliminate the interest cost. But with low interest your options open up a little bit.
If your interest rate is incredibly low — like some of the 3.25% 15-year mortgage or 4.0% 30-year mortgage rates available today — you can consider stretching out your payments to wait on inflation to make your payment inexpensive. With rates low enough, over time, your fixed rate mortgage cost will stay the same but the income you make will increase thanks to inflation. Your $700 mortgage payment today might represent 30% of your income, but in 15 years it could represent 20% of your income. (This is one of the only times inflation can be seen as a great thing!)
With high enough inflation (or a low enough rate) simply making your normal payment and using any money you would use on extra principal payments for other investments makes sense. If interest rates on online saving accounts return to the 4-5% range as they were at several years ago, your 3.5% mortgage looks like an amazing deal because every dollar saved instead of used on principal payments earns extra money for you.
On the other hand a low interest rate also enables you to wipe out your mortgage faster than if the rate was higher. You could pocket the extra money, but if you use it wisely you could pay off your house.
You’re still paying a significant amount of interest at the beginning of the mortgage due to how mortgage payments are structured, but your payment is much lower than it would have been a few years ago. That lower payment enables you to throw extra cash toward the balance and wipe out your mortgage completely. Your $700 payment at today’s rates might have been $900 a few years ago. If you put an extra $100 or $200 toward the balance you would expedite the payoff of your home.
Which option is best for you? Or should you pay a little bit toward the mortgage and use the remaining money elsewhere?
The decision of whether or not to pay off your home faster is dependent upon your own financial situation, your view on inflation, and what rate of return you can earn elsewhere. If you put extra money on your 3.5% mortgage you are basically earning a 3.5% return on your money by avoiding paying interest on the amount you pay off. If you think you can earn 8% elsewhere, it makes sense to avoid paying off your mortgage.
Likewise if you think inflation is about to run rampant in the economy for several years then locking in a low rate and sitting on it makes sense, too.
The only problem with anticipating investment or inflation growth is it is really hard to forecast what will happen in the future. Paying off your house isn’t necessarily a guaranteed return, either: you can eliminate the interest cost, but the value of a paid off home can go up and down as well. But if you plan on living in your home for a long time then paying it off, eliminating the monthly payment, and minimizing the interest you paid on your mortgage makes a lot of sense.
What are you doing with your mortgage?
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