In August 2022, I wrote “an argument for not paying extra on your mortgage“. I would like to expand on this a bit.

I generally fall into the conservative camp when it comes to money management and investing. I haven’t always been this way. But even when I was younger, I would still throw some extra money towards my mortgage.

I now have a ridiculously low mortgage rate at 2%, which is fixed. It is so low that it just doesn’t make sense to pay it down. Maybe if we had a deflationary depression and I had a bunch of money laying around, I would consider it then.

Even during more regular times with lower price inflation, I hear many financial talking heads recommend to never pay down the mortgage in most cases. They think you can do something better with your money.

In other words, they are arguing that you can get a better rate of return on the money that you would have used to pay down or pay off your mortgage. And maybe you can get a better rate. The question is: Will you get a better rate?

Guaranteed Return

I have heard the argument for a long time now that if you have a relatively low interest rate on your mortgage, then just take any money you would use to pay down the mortgage and invest it in the stock market. You will supposedly get a better return over time.

But this may or may not be true. And that’s really the whole point. If you have a mortgage rate of 4%, then you will likely have to get a return of 5% or more to come out ahead if it isn’t in a tax-sheltered account like a Roth IRA. If your money is in a regular brokerage account, then you will owe taxes on gains and dividends.

Even aside from taxes, you will still have to get a 4% return on stocks to break even as compared to paying down the mortgage with a 4% interest rate.

Historically, the U.S. stock market has returned higher than a 4% return over time. The problem is that we aren’t living in history. We are living now, and we are planning for the future.

Talk to someone in Japan who invested in Japanese stocks in 1989 and is still down today, even in nominal terms.

The point is that if you pay down the mortgage with a 4% interest rate, you are effectively getting a 4% tax-free return on your money. There is no guarantee you will get that with stocks. In fact, you might even lose money in the stock market.

Inflation Doesn’t Matter, Returns Matter

I keep hearing that it doesn’t make sense to pay down low-interest debt in today’s environment of higher inflation (price inflation). But I want it to be clear that it isn’t rising consumer prices that matter in this decision.

If you have $100,000 sitting in the bank earning 1% interest and losing 8% annually to price inflation, then you are better off taking the money and paying off a $100,000 mortgage with a 4% interest rate, or even a 2% interest rate rather than have it sit in the bank.

The key is that this isn’t your only option. You could buy assets that have a near 100% guarantee such as Treasury bills.

With higher interest rates today, you can actually get a decent nominal return in Treasury bills, and you can also look at Treasury Inflation-Protected Securities (TIPS).

If you can get a higher return after taxes that is nearly guaranteed, then this makes more sense than paying down your mortgage.

The important point is that the price inflation rate doesn’t really matter in this calculation. What matters is the rates of return you can get. It isn’t the rates of return you might be able to get. It is the returns you can get with a near guarantee.

If you are considering paying down your mortgage, the whole point is that you are getting the guarantee of not having to pay that interest.

Other Factors

There are many other factors to consider when paying down your mortgage. The person with $100,000 in the bank earning 1% may have good reasons to keep that money there.

It is important for most people to have an emergency fund and to have some liquidity. This is certainly a valid reason for keeping money in the bank and getting a low return.

Sometimes people want liquidity for more than an emergency expense too. Sometimes there are opportunities in business or investments that may come up. All of this should be considered.

There are many reasons for and against paying down a mortgage, and many of them are personal.

But you shouldn’t opt to never pay down your mortgage just because the rate of price inflation is high. The interest rates are what really matter. Sure, they tend to be higher with higher price inflation, but don’t confuse the two.