If you’re a homeowner with a mortgage, there’s a sweet spot you might not be aware of. It’s when your mortgage rate is lower than the 10-year bond yield. It’s like living rent-free! Instead of paying extra on your principal, you could invest the same amount as your mortgage into a 10-year Treasury bond. The interest you earn can cover your entire mortgage interest.
But what if you could do even better? Imagine having a negative real mortgage rate, thanks to inflation and low rates. You’re not technically living for free, but it sure feels like it when you adjust for inflation. So, there’s no need to rush to pay off your debt.
How do you know if you have a negative real mortgage rate? Just subtract the latest inflation rate from your mortgage rate. If the result is less than zero, congratulations, you have a negative real mortgage rate. In this case, you should slow down or even stop paying extra principal. It’s like borrowing money for free!
Let’s look at an example. In May 2022, the Consumer Price Index (CPI) was 8.6%. If your mortgage rate is less than this, you have a negative real mortgage rate. Enjoy it while it lasts, because inflation is essentially paying down your debt for you.
For instance, I took out a 7/1 ARM in 2020 with a mortgage rate of 2.125% for my primary residence. My real mortgage rate is -6.475% (2.125% minus 8.6%). It’s like I’m getting paid to borrow at a rate of 6.475%. Or you could see it as a 6.475% decrease in the real cost of my mortgage.
Inflation is a blessing for homeowners and debtors. The higher the inflation, the more your debt gets inflated away. Plus, your assets tend to increase in value. It’s a win-win situation.
But don’t worry, banks are still winning. Even if you’re only getting a measly 0.5% savings rate on $100,000 in cash, with inflation at 6.8%, your real savings rate is -6.4%. Your $100,000 can now only buy about $93,600 worth of goods compared to last year.
In a high inflationary environment, banks love gathering massive savings deposits when they don’t have to pay a high interest rate. They’re essentially borrowing free money from us to lend out for a profit.
Even though paying down a negative real mortgage might not be the best financial move, it’s still wise to pay off some debt with excess cash flow. If you don’t invest your cash, it’s getting negatively affected by inflation. Plus, the money you invest could always lose value. Paying down debt locks in a return equal to the nominal interest rate of the debt.
In a negative interest rate environment, embrace your debt. Taking out a mortgage to live a better life today is a great reason for taking on debt. If your house appreciates in value while the real mortgage interest rates go negative, you’re living the dream.
If you’re a renter, you can still win by investing your cash. Stocks tend to do well in an inflationary environment. You could also buy real estate ETFs, public REITs, private eREITs, and individual private real estate investments.
The person who loses in a negative interest rate environment is someone who holds all cash and never asks for or gets a raise. But the person who takes on too much leverage will also lose big if a downturn ever comes and they can’t hold on. So, proper risk control is necessary.
In our current high inflationary environment, I suggest slowing down your debt paydown schedule. Wait until inflation gets back down to about 3% before increasing your debt paydown again.
Investing in real estate is a powerful way to build wealth. Rising rents and rising capital values make real estate very attractive, especially with negative real mortgage rates.
You can invest in real estate without a mortgage through real estate crowdfunding. I’ve personally invested $810,000 in private real estate funds to diversify my holdings and earn more passive income.
Remember, no one economic scenario will last forever. You should always adapt your debt pay-down and investing strategy. And don’t forget, having cash gives you the liquid courage to take advantage of new investment opportunities. Get an investment right and it will more than make up for any losses due to inflation.
