Mortgage Rates and Inflation

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rockstar
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Mortgage Rates and Inflation

Post by rockstar »

In the past, my mortgage rate exceeded the inflation rate and the ten year treasury bond rate. It made more sense for me to prepay my mortgage than invest in a 10 year treasury bond, and I was earning a real rate of return. Now, inflation rates exceed my mortgage rate, and the ten year treasury is still way below it. It doesn't make sense for me to buy 10 year treasury bonds, but I did max out my electronic I Bonds this year.

Does it make sense to prepay my mortgage knowing that I will earn a negative rate of return?

I have no clue how long inflation will exceed mortgage rates.

What do you guys think? Am I thinking about this correctly? I was a kid in the 70s, so I didn't have to think about this back then. And this is the first time where I'm experiencing inflation rates higher than my mortgage rate. I usually apply my third paycheck this month to my mortgage as a prepayment (additional principal) as it's a three paycheck month.
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Re: Mortgage Rates and Inflation

Post by Call_Me_Op »

rockstar wrote: Sat Oct 16, 2021 1:25 pm In the past, my mortgage rate exceeded the inflation rate and the ten year treasury bond rate. It made more sense for me to prepay my mortgage than invest in a 10 year treasury bond, and I was earning a real rate of return. Now, inflation rates exceed my mortgage rate, and the ten year treasury is still way below it. It doesn't make sense for me to buy 10 year treasury bonds, but I did max out my electronic I Bonds this year.

Does it make sense to prepay my mortgage knowing that I will earn a negative rate of return?

I have no clue how long inflation will exceed mortgage rates.

What do you guys think? Am I thinking about this correctly? I was a kid in the 70s, so I didn't have to think about this back then. And this is the first time where I'm experiencing inflation rates higher than my mortgage rate. I usually apply my third paycheck this month to my mortgage as a prepayment (additional principal) as it's a three paycheck month.
Inflation has only been high for the past year ad is not expected to stay high.
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Ron Ronnerson
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Re: Mortgage Rates and Inflation

Post by Ron Ronnerson »

Situations can vary widely so some more context may be good to provide. Some questions:
What is the term & rate of your mortgage?
How many more years of payments do you have left and how much is the remaining balance?
What tax bracket are you in?
Married or single?
Are you currently maxing your retirement accounts?
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grabiner
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Re: Mortgage Rates and Inflation

Post by grabiner »

The fair comparison is not to inflation, but to the equivalent low-risk return you can earn. If you have 10 years left on your 3% mortgage, and can buy a 10-year bond at a 3% yield, then you break even by buying the bond rather than paying down the mortgage. If you can buy a bond at a 2.5% yield, there is a slight cost for buying the bond rather than paying down the mortgage, and you have to decide whether this is worth other benefits such as liquidity.

Currently, the yield on the 10-year Treasury bond is 1.59%, and on the 10-year TIPS is -0.97%, implying a break-even inflation rate of 2.56%. Thus, this is a reasonable expectation for the return on holding an I-Bond for ten years; you would then have to subtract federal tax.

And since this is risk-free, and higher than the return on marketable bonds, it might well make sense to buy I-Bonds rather than paying down a mortgage, but then be better to pay down the mortgage in preference to other taxable investments. (It doesn't matter whether the other taxable investments are in bonds or stocks, as long as you hold bonds somewhere; you could buy taxable stock, or pay down your mortgage and move an equal amount in your 401(k) from bonds to stocks for the same stock exposure.)
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Re: Mortgage Rates and Inflation

Post by JoeRetire »

rockstar wrote: Sat Oct 16, 2021 1:25 pm Does it make sense to prepay my mortgage knowing that I will earn a negative rate of return?
Not to me.
I have no clue how long inflation will exceed mortgage rates.
Nobody does.
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rockstar
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Re: Mortgage Rates and Inflation

Post by rockstar »

Ron Ronnerson wrote: Sat Oct 16, 2021 3:11 pm Situations can vary widely so some more context may be good to provide. Some questions:
What is the term & rate of your mortgage?
How many more years of payments do you have left and how much is the remaining balance?
What tax bracket are you in?
Married or single?
Are you currently maxing your retirement accounts?
30 year / 2.8% I refinanced last November, so 29 more years remain on the mortgage. The remaining balance is $333k. I have more than twice that in my taxable. My retirement accounts are all maxed out. Single. 35% tax bracket. I itemize. I have roughly $70k of yearly expenses.

My current plan is to prepay it at roughly a 20 year term and recast as I get closer to retirement. I couldn't get a better rate going 20 versus 30 at time of refi.

What I'm thinking about is should I prepay when inflation rates exceed my mortgage rates. I have no clue how long they will stay this high, but I wouldn't be surprised to see inflation rates at 3% or higher in the near future. They were this high when I graduated university.

I'm transitioning my emergency fund from checking into I Bonds. This will take a couple of years.
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Re: Mortgage Rates and Inflation

Post by Ron Ronnerson »

rockstar wrote: Sat Oct 16, 2021 4:46 pm
Ron Ronnerson wrote: Sat Oct 16, 2021 3:11 pm Situations can vary widely so some more context may be good to provide. Some questions:
What is the term & rate of your mortgage?
How many more years of payments do you have left and how much is the remaining balance?
What tax bracket are you in?
Married or single?
Are you currently maxing your retirement accounts?
30 year / 2.8% I refinanced last November, so 29 more years remain on the mortgage. The remaining balance is $333k. I have more than twice that in my taxable. My retirement accounts are all maxed out. Single. 35% tax bracket. I itemize. I have roughly $70k of yearly expenses.

My current plan is to prepay it at roughly a 20 year term and recast as I get closer to retirement. I couldn't get a better rate going 20 versus 30 at time of refi.

What I'm thinking about is should I prepay when inflation rates exceed my mortgage rates. I have no clue how long they will stay this high, but I wouldn't be surprised to see inflation rates at 3% or higher in the near future. They were this high when I graduated university.

I'm transitioning my emergency fund from checking into I Bonds. This will take a couple of years.
I Bonds are great right now. I'd definitely be maxing them out while inflation is high. I'm doing the same thing, by the way.

Since your retirement accounts are maxed out, let's focus on taxable investments with the extra cash you have at the end of the day. In the 35% bracket, you'd need to earn 4.3% before tax to end up with 2.8% after tax. If there are state taxes involved, the bar would be even higher. Other than I Bonds, can you earn such a high return elsewhere? Perhaps by investing in equities but then the risk level isn't the same so it's like comparing apples to oranges.

My first thought is that if you're planning to pay off the mortgage at the pace of roughly 20 years anyhow, you're maxing retirement accounts as well as I Bonds, your expenses are fairly low while your income is high, and you have a substantial amount in taxable already, why not try to refinance to a 15-year loan instead? It would likely involve just paying a few hundred dollars more per month, lower your rate, and reduce the total interest you'll have to pay over the life of the loan. If you're in the 35% bracket with only $70k of expenses, it doesn't seem like you need the additional liquidity that a longer term provides. Anyhow, I'd really consider refinancing again and probably moving on it quickly as rates could certainly rise from where they are. I think you could probably get a rate around 2% if you have good credit.
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rockstar
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Re: Mortgage Rates and Inflation

Post by rockstar »

Ron Ronnerson wrote: Sat Oct 16, 2021 5:34 pm
rockstar wrote: Sat Oct 16, 2021 4:46 pm
Ron Ronnerson wrote: Sat Oct 16, 2021 3:11 pm Situations can vary widely so some more context may be good to provide. Some questions:
What is the term & rate of your mortgage?
How many more years of payments do you have left and how much is the remaining balance?
What tax bracket are you in?
Married or single?
Are you currently maxing your retirement accounts?
30 year / 2.8% I refinanced last November, so 29 more years remain on the mortgage. The remaining balance is $333k. I have more than twice that in my taxable. My retirement accounts are all maxed out. Single. 35% tax bracket. I itemize. I have roughly $70k of yearly expenses.

My current plan is to prepay it at roughly a 20 year term and recast as I get closer to retirement. I couldn't get a better rate going 20 versus 30 at time of refi.

What I'm thinking about is should I prepay when inflation rates exceed my mortgage rates. I have no clue how long they will stay this high, but I wouldn't be surprised to see inflation rates at 3% or higher in the near future. They were this high when I graduated university.

I'm transitioning my emergency fund from checking into I Bonds. This will take a couple of years.
I Bonds are great right now. I'd definitely be maxing them out while inflation is high. I'm doing the same thing, by the way.

Since your retirement accounts are maxed out, let's focus on taxable investments with the extra cash you have at the end of the day. In the 35% bracket, you'd need to earn 4.3% before tax to end up with 2.8% after tax. If there are state taxes involved, the bar would be even higher. Other than I Bonds, can you earn such a high return elsewhere? Perhaps by investing in equities but then the risk level isn't the same so it's like comparing apples to oranges.

My first thought is that if you're planning to pay off the mortgage at the pace of roughly 20 years anyhow, you're maxing retirement accounts as well as I Bonds, your expenses are fairly low while your income is high, and you have a substantial amount in taxable already, why not try to refinance to a 15-year loan instead? It would likely involve just paying a few hundred dollars more per month, lower your rate, and reduce the total interest you'll have to pay over the life of the loan. If you're in the 35% bracket with only $70k of expenses, it doesn't seem like you need the additional liquidity that a longer term provides. Anyhow, I'd really consider refinancing again and probably moving on it quickly as rates could certainly rise from where they are. I think you could probably get a rate around 2% if you have good credit.
I like the liquidity because my salary isn't guaranteed to remain this high for the next 20 years. I hope it stays this high, but over that time period, I do expect at least one more recession.

Given a 20 year time frame, I think, I can reasonably take on more risk. I'd like to have enough to retire with a buffer in ten years, but I'm open to working 20 more. My biggest fear is ageism, which one of my friends is running into right now that is near retirement age. She worked in hospitality and got laid off when COVID hit last year. She's been trying to find a job for a while now, but she hasn't any luck finding anything close to her salary before getting laid off.
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Re: Mortgage Rates and Inflation

Post by Ron Ronnerson »

rockstar wrote: Sat Oct 16, 2021 5:52 pm
Ron Ronnerson wrote: Sat Oct 16, 2021 5:34 pm
rockstar wrote: Sat Oct 16, 2021 4:46 pm
Ron Ronnerson wrote: Sat Oct 16, 2021 3:11 pm Situations can vary widely so some more context may be good to provide. Some questions:
What is the term & rate of your mortgage?
How many more years of payments do you have left and how much is the remaining balance?
What tax bracket are you in?
Married or single?
Are you currently maxing your retirement accounts?
30 year / 2.8% I refinanced last November, so 29 more years remain on the mortgage. The remaining balance is $333k. I have more than twice that in my taxable. My retirement accounts are all maxed out. Single. 35% tax bracket. I itemize. I have roughly $70k of yearly expenses.

My current plan is to prepay it at roughly a 20 year term and recast as I get closer to retirement. I couldn't get a better rate going 20 versus 30 at time of refi.

What I'm thinking about is should I prepay when inflation rates exceed my mortgage rates. I have no clue how long they will stay this high, but I wouldn't be surprised to see inflation rates at 3% or higher in the near future. They were this high when I graduated university.

I'm transitioning my emergency fund from checking into I Bonds. This will take a couple of years.
I Bonds are great right now. I'd definitely be maxing them out while inflation is high. I'm doing the same thing, by the way.

Since your retirement accounts are maxed out, let's focus on taxable investments with the extra cash you have at the end of the day. In the 35% bracket, you'd need to earn 4.3% before tax to end up with 2.8% after tax. If there are state taxes involved, the bar would be even higher. Other than I Bonds, can you earn such a high return elsewhere? Perhaps by investing in equities but then the risk level isn't the same so it's like comparing apples to oranges.

My first thought is that if you're planning to pay off the mortgage at the pace of roughly 20 years anyhow, you're maxing retirement accounts as well as I Bonds, your expenses are fairly low while your income is high, and you have a substantial amount in taxable already, why not try to refinance to a 15-year loan instead? It would likely involve just paying a few hundred dollars more per month, lower your rate, and reduce the total interest you'll have to pay over the life of the loan. If you're in the 35% bracket with only $70k of expenses, it doesn't seem like you need the additional liquidity that a longer term provides. Anyhow, I'd really consider refinancing again and probably moving on it quickly as rates could certainly rise from where they are. I think you could probably get a rate around 2% if you have good credit.
I like the liquidity because my salary isn't guaranteed to remain this high for the next 20 years. I hope it stays this high, but over that time period, I do expect at least one more recession.

Given a 20 year time frame, I think, I can reasonably take on more risk. I'd like to have enough to retire with a buffer in ten years, but I'm open to working 20 more. My biggest fear is ageism, which one of my friends is running into right now that is near retirement age. She worked in hospitality and got laid off when COVID hit last year. She's been trying to find a job for a while now, but she hasn't any luck finding anything close to her salary before getting laid off.
It sounds like you're taking the middle road with a plan to pay off a 30-year loan on a 20-year schedule. It's unfortunate that rates for 20-year mortgages are the same (or almost the same) as for 30-year loans. If you're wanting the increased liquidity due to concerns about the stability of your job/pay, I would not be making additional payments toward the house. Instead, I'd save the money elsewhere and pay off the mortgage all at once when I was in a position to do so. That allows you to keep liquidity for the time being and hopefully puts you in a position to be able to lower your expenses in the future (when you either recast or pay off the mortgage).
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Re: Mortgage Rates and Inflation

Post by babystep »

Age? Taxable balance? 401k balance? Roth balance? How much bonds in taxable?
How much are you contributing to 401k, taxable and roth?
Topic Author
rockstar
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Re: Mortgage Rates and Inflation

Post by rockstar »

babystep wrote: Sat Oct 16, 2021 6:31 pm Age? Taxable balance? 401k balance? Roth balance? How much bonds in taxable?
How much are you contributing to 401k, taxable and roth?
45

I have $1.5m split 50/50 between taxable and tax deferred.

I have $10k in I Bonds. When my treasury bills matured last year, I rolled over the monies into equities, which is now 90% split between VOO (100% of the equivalent in my 401k) and QQQ. The other 10% is in a bunch of miscellaneous stuff such as: DIS, AMZN, IWM, GLD, TQQQ, VNQ, and REET. The 10% keeps me from messing with the other 90%.

I max out my 401k plus match, which is about $25k a year. And I add about $50-60k to taxable a year. I don't have a Roth as I made the mistake of rolling over an old 401k to a traditional IRA that now has about $300k in it. I do have a 401k Roth available, but at my tax bracket, I prefer to defer assuming that I'll be in a much lower tax bracket when I retire. My biggest concern here is potentially high RMDs in my 70s when I expect to collect social security. When I get married, I might start using the 401k Roth. And I'm currently paying down a little over $12k a year on my mortgage a year.

As I said earlier, my expenses are $70k. That includes my mortgage, which I'm most likely going to pay off right before I retire.

Does this help?
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Re: Mortgage Rates and Inflation

Post by babystep »

rockstar wrote: Sat Oct 16, 2021 7:14 pm
babystep wrote: Sat Oct 16, 2021 6:31 pm Age? Taxable balance? 401k balance? Roth balance? How much bonds in taxable?
How much are you contributing to 401k, taxable and roth?
45

I have $1.5m split 50/50 between taxable and tax deferred.

I have $10k in I Bonds. When my treasury bills matured last year, I rolled over the monies into equities, which is now 90% split between VOO (100% of the equivalent in my 401k) and QQQ. The other 10% is in a bunch of miscellaneous stuff such as: DIS, AMZN, IWM, GLD, TQQQ, VNQ, and REET. The 10% keeps me from messing with the other 90%.

I max out my 401k plus match, which is about $25k a year. And I add about $50-60k to taxable a year. I don't have a Roth as I made the mistake of rolling over an old 401k to a traditional IRA that now has about $300k in it. I do have a 401k Roth available, but at my tax bracket, I prefer to defer assuming that I'll be in a much lower tax bracket when I retire. My biggest concern here is potentially high RMDs in my 70s when I expect to collect social security. When I get married, I might start using the 401k Roth. And I'm currently paying down a little over $12k a year on my mortgage a year.

As I said earlier, my expenses are $70k. That includes my mortgage, which I'm most likely going to pay off right before I retire.

Does this help?
Thanks for adding the details.
If I understand correctly then you don't have much bonds at all. Mortgage is 30 year fixed at 2.8% and 35% tax bracket.

Now, to your original question.
rockstar wrote: Sat Oct 16, 2021 7:14 pm Does it make sense to prepay my mortgage knowing that I will earn a negative rate of return?
I would say yes it does make sense to prepay.

You are in high bracket and mostly allocated to stocks. High bracket means that tax equivalent zero risk bonds would yield much less so better to pay-down. The glide path (may be 5-10 years from now) would suggest to buy bonds then why not just pay-down for better return.

Your taxable balance is high so not a problem with the liquidity that means paying down will not result in liquidity issues.

RMDs: If you are not working say b/w 60 and 72 then there will be lot of opportunities to do the Roth conversion.

I presume that employer doesn't allow roll-over from IRA to 401k? How about sending an email to HR about requesting this feature? Many at your company will benefit. You will be able to do backdoor Roth after IRA is rolled into the 401k.

Either way, you are in great position.
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Re: Mortgage Rates and Inflation

Post by KlangFool »

rockstar wrote: Sat Oct 16, 2021 7:14 pm
babystep wrote: Sat Oct 16, 2021 6:31 pm Age? Taxable balance? 401k balance? Roth balance? How much bonds in taxable?
How much are you contributing to 401k, taxable and roth?
45

I have $1.5m split 50/50 between taxable and tax deferred.
rockstar,

1) You are about 100% stock.

2) And, just to increase your RISK further, you want to reduce your LIQUIDITY by pre-paying the mortgage.

3) You have 1.5 million. Your annual expense is about 70K per year. You are at 21.4 years of annual expense.

4) Your annual savings is about 85K. 1.5 million is equal to about 17+ years of your annual savings.

5) You do not believe anything can go wrong.

6) I wish you the best of lucks.

KlangFool
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Re: Mortgage Rates and Inflation

Post by willthrill81 »

rockstar wrote: Sat Oct 16, 2021 1:25 pmDoes it make sense to prepay my mortgage knowing that I will earn a negative rate of return?
Let me rephrase this question in a way that may be enlightening: does it make sense to buy bonds with a negative real yield?
The Sensible Steward
Topic Author
rockstar
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Re: Mortgage Rates and Inflation

Post by rockstar »

babystep wrote: Sat Oct 16, 2021 8:30 pm
rockstar wrote: Sat Oct 16, 2021 7:14 pm
babystep wrote: Sat Oct 16, 2021 6:31 pm Age? Taxable balance? 401k balance? Roth balance? How much bonds in taxable?
How much are you contributing to 401k, taxable and roth?
45

I have $1.5m split 50/50 between taxable and tax deferred.

I have $10k in I Bonds. When my treasury bills matured last year, I rolled over the monies into equities, which is now 90% split between VOO (100% of the equivalent in my 401k) and QQQ. The other 10% is in a bunch of miscellaneous stuff such as: DIS, AMZN, IWM, GLD, TQQQ, VNQ, and REET. The 10% keeps me from messing with the other 90%.

I max out my 401k plus match, which is about $25k a year. And I add about $50-60k to taxable a year. I don't have a Roth as I made the mistake of rolling over an old 401k to a traditional IRA that now has about $300k in it. I do have a 401k Roth available, but at my tax bracket, I prefer to defer assuming that I'll be in a much lower tax bracket when I retire. My biggest concern here is potentially high RMDs in my 70s when I expect to collect social security. When I get married, I might start using the 401k Roth. And I'm currently paying down a little over $12k a year on my mortgage a year.

As I said earlier, my expenses are $70k. That includes my mortgage, which I'm most likely going to pay off right before I retire.

Does this help?
Thanks for adding the details.
If I understand correctly then you don't have much bonds at all. Mortgage is 30 year fixed at 2.8% and 35% tax bracket.

Now, to your original question.
rockstar wrote: Sat Oct 16, 2021 7:14 pm Does it make sense to prepay my mortgage knowing that I will earn a negative rate of return?
I would say yes it does make sense to prepay.

You are in high bracket and mostly allocated to stocks. High bracket means that tax equivalent zero risk bonds would yield much less so better to pay-down. The glide path (may be 5-10 years from now) would suggest to buy bonds then why not just pay-down for better return.

Your taxable balance is high so not a problem with the liquidity that means paying down will not result in liquidity issues.

RMDs: If you are not working say b/w 60 and 72 then there will be lot of opportunities to do the Roth conversion.

I presume that employer doesn't allow roll-over from IRA to 401k? How about sending an email to HR about requesting this feature? Many at your company will benefit. You will be able to do backdoor Roth after IRA is rolled into the 401k.

Either way, you are in great position.
I thought about rolling over my tIRA into my 401k, but my 401k charges 21bps on top of the ER of the funds. Now, I just got a lower ER fund close to VOO for this first time this year. Before this year, the S&P500 index fund cost 30bps for a combined 51bps. I didn't want to pay the higher fees. My 401k also has trading restrictions on transactions of more than $25k a month. I'm not sure if I want to jump through all of these hoops. However, once I get married, my tax bracket will drop, so that's why I'm thinking about the Roth 401k for future contributions.
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Re: Mortgage Rates and Inflation

Post by rockstar »

willthrill81 wrote: Sat Oct 16, 2021 8:53 pm
rockstar wrote: Sat Oct 16, 2021 1:25 pmDoes it make sense to prepay my mortgage knowing that I will earn a negative rate of return?
Let me rephrase this question in a way that may be enlightening: does it make sense to buy bonds with a negative real yield?
That's where my head is at. Before the inflation spiked, prepaying my mortgage resulted in a real return. It wasn't much, but it wasn't negative. And since I itemize, I can deduct my mortgage interest, so my effective rate is much lower. This will go away after I get married as the standard deduction will double. But even with this effective rate lower, I was still "earning" a real return when subtracting roughly 1.7% inflation against my effective rate. Now, that's no longer the case at inflation rates this year.

If you go back to the discussion of treating a mortgage as a bond portion of your portfolio, this question should start to make sense.

It should also make sense now why I'm not holding any bonds other than I Bonds. I haven't held bonds since 2020, which had been treasury bills with maturities less than a year. This was before I learned about duration matching here.
Last edited by rockstar on Sat Oct 16, 2021 9:10 pm, edited 1 time in total.
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Re: Mortgage Rates and Inflation

Post by rockstar »

KlangFool wrote: Sat Oct 16, 2021 8:51 pm
rockstar wrote: Sat Oct 16, 2021 7:14 pm
babystep wrote: Sat Oct 16, 2021 6:31 pm Age? Taxable balance? 401k balance? Roth balance? How much bonds in taxable?
How much are you contributing to 401k, taxable and roth?
45

I have $1.5m split 50/50 between taxable and tax deferred.
rockstar,

1) You are about 100% stock.

2) And, just to increase your RISK further, you want to reduce your LIQUIDITY by pre-paying the mortgage.

3) You have 1.5 million. Your annual expense is about 70K per year. You are at 21.4 years of annual expense.

4) Your annual savings is about 85K. 1.5 million is equal to about 17+ years of your annual savings.

5) You do not believe anything can go wrong.

6) I wish you the best of lucks.

KlangFool
I absolutely believe a lot can go wrong. But I don't think holding negative real yielding bonds is the answer while still working. Once I can get a positive real yield, I'll start buying bonds again.
moneyflowin
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Re: Mortgage Rates and Inflation

Post by moneyflowin »

When interest rates are low combined with high inflation, Econ 101 says that you should be a borrower. You're paying off your loan with less valuable dollars. You're winning; the lender is losing because the interest rate isn't adequately compensating them for the rapid devaluing of the dollar.

Pay it off as slowly as possible
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Re: Mortgage Rates and Inflation

Post by willthrill81 »

rockstar wrote: Sat Oct 16, 2021 9:06 pm
willthrill81 wrote: Sat Oct 16, 2021 8:53 pm
rockstar wrote: Sat Oct 16, 2021 1:25 pmDoes it make sense to prepay my mortgage knowing that I will earn a negative rate of return?
Let me rephrase this question in a way that may be enlightening: does it make sense to buy bonds with a negative real yield?
That's where my head is at. Before the inflation spiked, prepaying my mortgage resulted in a real return. It wasn't much, but it wasn't negative. And since I itemize, I can deduct my mortgage interest, so my effective rate is much lower. This will go away after I get married as the standard deduction will double. But even with this effective rate lower, I was still "earning" a real return when subtracting roughly 1.7% inflation against my effective rate. Now, that's no longer the case at inflation rates this year.

If you go back to the discussion of treating a mortgage as a bond portion of your portfolio, this question should start to make sense.

It should also make sense now why I'm not holding any bonds other than I Bonds. I haven't held bonds since 2020, which had been treasury bills with maturities less than a year. This was before I learned about duration matching here.
Keep in mind that today's inflation rates are not the same as what inflation rates will average over the next X years. The inflation rate has fluctuated quite a bit over the last 25 years alone, as the graph below indicates.

Image
https://tradingeconomics.com/united-sta ... lation-cpi

Surprisingly, the annualized rate of inflation since 1996 has only been 2.3%, including this year's inflation spike.

We're in an....interesting....period. Stock valuations are high, bond yields are very low, and no assets are cheap.

If inflation continues at anywhere close to its current rate, I don't see how the Fed can get around raising rates. And if they do, future bond yields might exceed today's mortgage rates. But those might be some big 'ifs'.
The Sensible Steward
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Re: Mortgage Rates and Inflation

Post by KlangFool »

rockstar wrote: Sat Oct 16, 2021 9:09 pm
I absolutely believe a lot can go wrong. But I don't think holding negative real yielding bonds is the answer while still working. Once I can get a positive real yield, I'll start buying bonds again.
rockstar,

In summary, you believe a lot can go wrong but not working is not possible. I wish you the best of luck.

Once upon a time, I believe that. Then, Telecom Bust happened.

KlangFool
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Topic Author
rockstar
Posts: 6308
Joined: Mon Feb 03, 2020 5:51 pm

Re: Mortgage Rates and Inflation

Post by rockstar »

willthrill81 wrote: Sat Oct 16, 2021 9:21 pm
rockstar wrote: Sat Oct 16, 2021 9:06 pm
willthrill81 wrote: Sat Oct 16, 2021 8:53 pm
rockstar wrote: Sat Oct 16, 2021 1:25 pmDoes it make sense to prepay my mortgage knowing that I will earn a negative rate of return?
Let me rephrase this question in a way that may be enlightening: does it make sense to buy bonds with a negative real yield?
That's where my head is at. Before the inflation spiked, prepaying my mortgage resulted in a real return. It wasn't much, but it wasn't negative. And since I itemize, I can deduct my mortgage interest, so my effective rate is much lower. This will go away after I get married as the standard deduction will double. But even with this effective rate lower, I was still "earning" a real return when subtracting roughly 1.7% inflation against my effective rate. Now, that's no longer the case at inflation rates this year.

If you go back to the discussion of treating a mortgage as a bond portion of your portfolio, this question should start to make sense.

It should also make sense now why I'm not holding any bonds other than I Bonds. I haven't held bonds since 2020, which had been treasury bills with maturities less than a year. This was before I learned about duration matching here.
Keep in mind that today's inflation rates are not the same as what inflation rates will average over the next X years. The inflation rate has fluctuated quite a bit over the last 25 years alone, as the graph below indicates.

Image
https://tradingeconomics.com/united-sta ... lation-cpi

Surprisingly, the annualized rate of inflation since 1996 has only been 2.3%, including this year's inflation spike.

We're in an....interesting....period. Stock valuations are high, bond yields are very low, and no assets are cheap.

If inflation continues at anywhere close to its current rate, I don't see how the Fed can get around raising rates. And if they do, future bond yields might exceed today's mortgage rates. But those might be some big 'ifs'.
I can't imagine the Fed not raising rates within the next two years. This makes bonds even more scary in the short term. However, if bond yields go up, the risk free rate goes up, so equities should get pinched too. And if the ten year goes up a lot, we are likely to see mortgage rates go up as well, which will make homes even more unaffordable, which should put pressure on home prices. The best case scenario would be a flattening of the curve, but that doesn't seem likely with tapering. This is a big mess and makes investing super difficult. The challenge is with rates so low, it's hard to think about the playbook that worked for the last 30 years, where bond yields continue to go down after every recession.

If, I think, I'm going to work for 10-20 more years, I need to make decisions with that term in mind for the accumulation phase. And I need to figure out how I'm going to approach drawing down in the future. So much uncertainty.

My expectation is that we see the inflation rate around 3ish percent for the next two years. I hope I'm wrong.
Topic Author
rockstar
Posts: 6308
Joined: Mon Feb 03, 2020 5:51 pm

Re: Mortgage Rates and Inflation

Post by rockstar »

KlangFool wrote: Sat Oct 16, 2021 9:46 pm
rockstar wrote: Sat Oct 16, 2021 9:09 pm
I absolutely believe a lot can go wrong. But I don't think holding negative real yielding bonds is the answer while still working. Once I can get a positive real yield, I'll start buying bonds again.
rockstar,

In summary, you believe a lot can go wrong but not working is not possible. I wish you the best of luck.

Once upon a time, I believe that. Then, Telecom Bust happened.

KlangFool
I can always get a job. But I can't guarantee I'll make the same salary. That's what I said above when asked why I didn't get a 15 year mortgage.
invest4
Posts: 1893
Joined: Wed Apr 24, 2019 2:19 am

Re: Mortgage Rates and Inflation

Post by invest4 »

moneyflowin wrote: Sat Oct 16, 2021 9:14 pm When interest rates are low combined with high inflation, Econ 101 says that you should be a borrower. You're paying off your loan with less valuable dollars. You're winning; the lender is losing because the interest rate isn't adequately compensating them for the rapid devaluing of the dollar.

Pay it off as slowly as possible
Agreed.

30 year mortgage at historically low rates provides:

* Inflation hedge

* Options

* Low return hurdle (2.625% in my case)
KlangFool
Posts: 31426
Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Rates and Inflation

Post by KlangFool »

rockstar wrote: Sat Oct 16, 2021 10:08 pm
KlangFool wrote: Sat Oct 16, 2021 9:46 pm
rockstar wrote: Sat Oct 16, 2021 9:09 pm
I absolutely believe a lot can go wrong. But I don't think holding negative real yielding bonds is the answer while still working. Once I can get a positive real yield, I'll start buying bonds again.
rockstar,

In summary, you believe a lot can go wrong but not working is not possible. I wish you the best of luck.

Once upon a time, I believe that. Then, Telecom Bust happened.

KlangFool
I can always get a job. But I can't guarantee I'll make the same salary. That's what I said above when asked why I didn't get a 15 year mortgage.
Why do you believe you could always get a job, I have no idea. I wish you the best of luck.

If you don't believe it is safe to take 15 years mortgage, why is it safe to prepay the 30 years mortgage?

KlangFool
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l8_apex
Posts: 69
Joined: Fri Mar 08, 2019 9:57 am

Re: Mortgage Rates and Inflation

Post by l8_apex »

Since nobody has mentioned it (or I simply missed it) and because you have enough in taxable, I'd suggest that you look into replacing your mortgage with a margin loan. Right now you can get such a loan with a rate of about 1.2%. Not tax deductible, but it's so much lower than a more traditional mortgage that the difference in taxation becomes trivial. Interest-only payment on that is OK too.

The big caveat, leave enough of a buffer between stock value to loan amount in case of a market crash. Second level buffer: take out a HELOC but don't use it except in the emergency of a market crash.

Can something go wrong, yes. Weigh the risk to reward.

There has been some discussion here about margin loans and also at the Mr MoneyMustache forums.
KlangFool
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Re: Mortgage Rates and Inflation

Post by KlangFool »

OP,

A) You have 1.5 million now.

B) Your annual expense is 70K per year.

C) Your annual savings is 85K per year.

D) You can reach your number with an AA of 70/30 with on the average return of 1% less per year.

E) You can be protected even if you are not working or working with a lower salary.

F) Why are you taking unnecessary RISK of 100% stock and individual stock?

KlangFool
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Topic Author
rockstar
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Joined: Mon Feb 03, 2020 5:51 pm

Re: Mortgage Rates and Inflation

Post by rockstar »

KlangFool wrote: Sun Oct 17, 2021 12:42 pm OP,

A) You have 1.5 million now.

B) Your annual expense is 70K per year.

C) Your annual savings is 85K per year.

D) You can reach your number with an AA of 70/30 with on the average return of 1% less per year.

E) You can be protected even if you are not working or working with a lower salary.

F) Why are you taking unnecessary RISK of 100% stock and individual stock?

KlangFool
I had a 70/30 portfolio before real bond yields went negative. I wasn't in BND, but I was holding individual treasury bills that I had bought at auction that I continuously rolled over. Now, I think, there is risk on both the equity side and bond side. Equity values are stretched. And bond yields are failing terribly against inflation. I hate both. My REIT position is insignificant. But I expect higher rates to negative impact it as well.

I honestly don't know what to do about risk today.

As for your job comment above, I wouldn't feel at all bad working at a grocery store or being an Uber driver. I remember when one of my friend's dad got laid off that he ended up working as a pizza delivery guy until he found something better again. I'll do whatever it takes.

How are you managing risk? BND is running about 7% negative real at the moment if you assume a 5% inflation rate while the S&P500 is about a positive 14% real.

https://www.morningstar.com/etfs/xnas/bnd/performance

I'm still thinking through the prepayment. I have another week before I have to setup my mortgage payment.
KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Rates and Inflation

Post by KlangFool »

rockstar wrote: Sun Oct 17, 2021 1:12 pm

How are you managing risk? BND is running about 7% negative real at the moment if you assume a 5% inflation rate while the S&P500 is about a positive 14% real.
rockstar,

My AA is 60/40. I do not need to take additional RISK. You can see my portfolio in the signature.

I only pay down my mortgage when I am Financially Independent. As in NOW.

<<BND is running about 7% negative real at the moment if you assume a 5% inflation rate while the S&P500 is about a positive 14% real.>>

I know enough to know that those predictions are useless. I know that I know nothing. I know when someone pretend to know something.

<<I wouldn't feel at all bad working at a grocery store or being an Uber driver. I remember when one of my friend's dad got laid off that he ended up working as a pizza delivery guy until he found something better again. I'll do whatever it takes.>>

At your annual expense of 70K per year, it would not be enough to cover your annual expenses. If the stock market drops 50% at the same time, you will be selling stock at a 50% loss to cover the difference. If it lasted long enough, you will lose enough that you would never recover.

At March 2020, the stock market drop 30+% and the BND drop 7%. The BND did its job.

KlangFool
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Ron Ronnerson
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Location: Bay Area

Re: Mortgage Rates and Inflation

Post by Ron Ronnerson »

rockstar wrote: Sun Oct 17, 2021 1:12 pm
KlangFool wrote: Sun Oct 17, 2021 12:42 pm OP,

A) You have 1.5 million now.

B) Your annual expense is 70K per year.

C) Your annual savings is 85K per year.

D) You can reach your number with an AA of 70/30 with on the average return of 1% less per year.

E) You can be protected even if you are not working or working with a lower salary.

F) Why are you taking unnecessary RISK of 100% stock and individual stock?

KlangFool
I had a 70/30 portfolio before real bond yields went negative. I wasn't in BND, but I was holding individual treasury bills that I had bought at auction that I continuously rolled over. Now, I think, there is risk on both the equity side and bond side. Equity values are stretched. And bond yields are failing terribly against inflation. I hate both. My REIT position is insignificant. But I expect higher rates to negative impact it as well.

I honestly don't know what to do about risk today.

As for your job comment above, I wouldn't feel at all bad working at a grocery store or being an Uber driver. I remember when one of my friend's dad got laid off that he ended up working as a pizza delivery guy until he found something better again. I'll do whatever it takes.

How are you managing risk? BND is running about 7% negative real at the moment if you assume a 5% inflation rate while the S&P500 is about a positive 14% real.

https://www.morningstar.com/etfs/xnas/bnd/performance

I'm still thinking through the prepayment. I have another week before I have to setup my mortgage payment.
I think KlangFool brings up very valid points. If you think your income is not all that stable and have $1.5m invested, the risk posed from a stock market crash when you're invested almost entirely in stocks would be a far bigger concern than bonds returning slightly negative yields at the current moment. Imagine if bonds return -5% over the next year while stocks return -50%. This is a possible outcome and you're exposed to it. It's best to take on an amount of risk that you can handle. You need to assess this carefully.

I'm almost the same age as you (46) and am at roughly 78% stocks and 22% bonds. This is the amount I've decided I can handle right now (I'm a tenured teacher expecting a six-figure pension so a short-term downturn doesn't scare me all that much and even then, I'm slowly inching toward 25% bonds). I am slowly increasing my bond holdings as I age regardless of what is happening in the economy or in world news. I wouldn't try to time the market.
KlangFool
Posts: 31426
Joined: Sat Oct 11, 2008 12:35 pm

Re: Mortgage Rates and Inflation

Post by KlangFool »

rockstar wrote: Sun Oct 17, 2021 1:12 pm
How are you managing risk? BND is running about 7% negative real at the moment if you assume a 5% inflation rate while the S&P500 is about a positive 14% real.
rockstar,

Let's be honest. You really do not believe in any of those predictions. If you do, you would not be thinking of paying down your mortgage.

if you think both the stock and the bond are RISKY, you would keep more CASH. The HOUSE would not be safe either. Your home equity could be wiped out too.

Please THINK carefully.

KlangFool
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