Should I pay off mortgage when inflation is high?

Quick Answer

There is no definitive answer on whether to pay off a mortgage early when inflation is high. It depends on your personal financial situation, mortgage interest rate, whether you itemize deductions, and your investment opportunities. Paying off a low, fixed-rate mortgage may not make sense if inflation is rising, since that debt gets cheaper in real terms over time. However, paying off high-interest debt can provide guaranteed returns greater than inflation. Run the numbers for your situation before deciding.

Should I pay extra toward my mortgage principal with high inflation?

With high inflation, paying extra toward your mortgage principal may not make sense if you have a low fixed interest rate. Here’s why:

  • Inflation reduces the “real” cost of fixed-rate debt like a mortgage over time. If your mortgage rate is 3% and inflation is 8%, your real interest rate is -5%.
  • That money may be better invested elsewhere to hedge against inflation. Stock market returns have historically exceeded inflation over the long run.
  • Prepaying a mortgage results in a guaranteed return equal to your interest rate. But stocks and real estate can provide higher potential returns.

However, if you have a high mortgage interest rate, paying it down faster guarantees you a return equal to that rate, which likely exceeds inflation. Run the numbers to see which option gives the best risk-adjusted returns.

Should I prioritize mortgage prepayments or increase retirement contributions?

With high inflation, it may be wise to prioritize increasing retirement contributions over extra mortgage payments for a few key reasons:

  • Retirement accounts like 401(k)s and IRAs provide valuable tax advantages that allow faster growth potential.
  • Stock market returns can provide a hedge against inflation, since equities tend to rise with inflation over the long run.
  • Mortgage rates are near historic lows, so the guaranteed return from paying extra principal may be lower than future market returns.

However, once retirement contributions are maxed out, extra mortgage payments can provide a guaranteed return and faster equity build-up. Consider a balanced approach, increasing both in tandem. Work with a financial planner to determine the optimal strategy.

How does mortgage interest deduction change with high inflation?

The value of the mortgage interest tax deduction declines when inflation is high, assuming your interest rate is fixed. Here’s how it works:

  • The mortgage interest deduction allows you to reduce taxable income by your annual mortgage interest paid.
  • But with high inflation, the “real” value of the deduction falls every year.
  • For example, a $5,000 deduction this year may only be worth $4,500 in real terms next year if inflation is 10%.

So don’t let the mortgage interest deduction overly influence your decision on whether to pay off a mortgage. Run the numbers to see if the guaranteed after-tax returns from paying off the mortgage exceed alternative uses for the funds.

Should I refinance my mortgage with high inflation?

Refinancing your mortgage can make sense with high inflation if you can get a significantly lower interest rate. Here are a few factors to consider:

  • Compare new rates to your existing rate – is the reduction enough to justify refi costs?
  • Option to shorten loan term to pay mortgage off faster while rates are low.
  • Closing costs will be paid back faster when inflation is high.
  • Shop multiple lenders to find lowest rate/fees.

However, if new rates are only marginally lower than your current fixed mortgage, or you plan to move soon, refinancing may not be worth it. Use a mortgage refinance calculator to estimate potential savings.

Should I use extra cash to pay down student loans or my mortgage?

With high inflation, it may make more sense to pay off higher-interest student loans before making extra mortgage payments:

  • Federal and private student loan rates can exceed mortgage rates, so pay down highest rates first.
  • Student loan interest is not tax deductible like mortgage interest.
  • Paying loans faster limits interest expenses when inflation is eroding value of money.

However, once student loans are paid off, consider directing extra payments to the mortgage to accelerate paying off that fixed-rate debt before inflation rises further. A balanced approach helps maximize interest savings.

Should I take equity out of my home to pay off the mortgage?

With inflation high, tapping into your home’s equity to pay off your mortgage is generally not recommended:

  • Equity loans or lines of credit have higher variable interest rates than fixed-rate mortgages.
  • Paying off a low fixed-rate mortgage saves little when inflation is high.
  • Investment returns may exceed mortgage rates, so keep equity invested.
  • Owning your home free and clear reduces inflation risk.

However, a HELOC may provide cheaper funds to pay off high-interest credit card or auto debt. Run the numbers carefully to be sure the interest savings exceed the HELOC rate. Maintain financial flexibility.

Should I buy I-Bonds to hedge inflation instead of prepaying mortgage?

Buying I-Bonds may be a smart move with high inflation instead of prepaying a low fixed-rate mortgage. Here’s why:

  • I-Bonds earn interest rates that adjust with inflation every 6 months.
  • Rates recently hit 9.62% and will likely remain high given elevated inflation.
  • Interest earned is exempt from state/local tax and deferred from federal tax.
  • Up to $10k per person can be invested annually.
  • Downside is 1-year lockup and loss of 3 months interest if sold before 5 years.

I-Bonds hedge inflation far better than paying down a mortgage with a rate lower than inflation. This year especially, I-Bonds provide significantly higher risk-free returns.

Should I use extra mortgage payments or invest more in real estate?

Investing surplus cash into real estate may be a smarter inflation hedge than prepaying a low fixed-rate mortgage when inflation is high. Here’s why:

  • Rents and property values tend to rise with inflation over time.
  • Additional properties provide rental income and appreciation potential above a primary home.
  • Owning real estate diversifies away from dollar-denominated assets.
  • Write-offs, depreciation and tax-deferred 1031 exchanges add value.

However, higher-rate mortgages above ~5% are worth paying down faster. And real estate investing requires significant expertise, capital and tolerance for risk. For most, paying down a primary home mortgage guarantees attractive after-tax returns.

Should I pay down my mortgage or invest spare cash?

With inflation high, investing spare cash likely provides better inflation-adjusted returns over time compared to making extra mortgage payments. Here are a few key points:

  • Stocks tend to provide returns exceeding inflation over long periods.
  • Bond returns lag during inflationary periods but provide solid income.
  • Paying down low fixed-rate mortgages results in lower guaranteed returns.
  • Maintain an emergency fund before extra mortgage payments.

However, once you have sufficient retirement and taxable investing accounts, extra mortgage payments provide a guaranteed return equal to your interest rate. Find the right balance based on your risk tolerance and time horizon.

Should I pay off my mortgage if I think inflation will get much worse?

It can make sense to aggressively pay down your mortgage if you believe high inflation will persist or drastically worsen in the coming years. Here are some factors to consider:

  • Owning your home free and clear avoids inflation risk on housing costs.
  • Locks in historically low fixed mortgage rates before further inflation.
  • Peace of mind knowing housing costs are covered in retirement.
  • Frees up monthly cash flow for other expenses if inflation spikes.

However, forecasting future inflation is extremely difficult. A balanced approach of modest extra mortgage payments plus conservative investments may hedge inflation risk while keeping financial options open. Remain nimble if inflation moderates.

Conclusion

With inflation running high, it’s smart to consider tactics to minimize erosion of your money’s purchasing power over time. Making extra mortgage principal payments can provide guaranteed returns to help counter inflation, but likely makes the most sense for mortgages over 5% interest. For lower fixed-rate mortgages, contributing more to retirement accounts, investing in assets like stocks/real estate and buying inflation-indexed bonds can provide more upside with only moderately higher risk. Use a balanced approach, as no one inflation hedge is perfect or ensures success. Monitor inflation trends closely and adjust your strategies over time to optimize outcomes.

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