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You and Your 3% Mortgage

Strategies for a low-rate home loan in a high-rate world

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Andre Rucker

If you bought a house or refinanced your mortgage in the decade leading up to the spring of 2022, you have a right to feel lucky. Mortgage rates were often below 4 percent in those years, reaching an all-time low of 2.65 percent in January 2021. Then came inflation. As of early February, the average 30-year fixed mortgage rate had risen to 6.63 percent. 

“In the world of mortgages, that’s a gigantic difference,” says Jacob Channel, the senior economist at LendingTree. Getting a rate that is nearly twice as big “could increase your monthly payments by thousands of dollars.”

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With a low fixed-rate mortgage, you can, of course, sit tight and just keep making payments. But the rise in overall interest rates, which affect savers as well as borrowers, might make you ponder whether you should adjust your money or home plans. Here are some answers.​

Prepay the mortgage 

The inflation-linked trend of stronger investment yields and higher wages may have you thinking that you can now afford either to pay off your mortgage or accelerate your payments. But these probably aren’t wise choices. Better to invest that extra money instead, locking in returns at levels higher than your current mortgage rate.

“If your kids are done with college or your income has gone up and you have some more savings capacity, instead of paying down the low-rate mortgage faster, another conservative approach is to put that money in a money market account” that yields a few percentage points more than your mortgage rate, says Roger Young, thought leadership director at T. Rowe Price. “Do that automatically for a while.” The extra savings will be easier to access than they would be if tied up in your house.

Estimate Your Savings

AARP’s Mortgage Payoff Calculator can help you see how much you can save with an early payoff.

Though money market funds have the advantage of liquidity — you can cash them in almost instantly without any cost or penalty — the downside is that there’s no guarantee that their yields will stay high for long. Another tactic is to instead purchase U.S. Treasury debt, which has a guaranteed yield over the life of the note, thus locking in a rate for longer. (Seven- and 10-year notes currently yield about 4 percent.) You’ll get the full value of the bond if you ‧hold it to maturity.

A related investment strategy, known as laddering, is to buy a series of different bonds maturing in different years — for example, three, five and seven years from now. “Bond yields are higher now than they’ve been in over 15 years,” says Michelle Morris, a financial planner with Brio Financial Planning in Quincy, Massachusetts. “Instead of prepaying a mortgage costing 3 percent, use the cash to buy a Treasury bond ladder paying more. There’s no rule against having a mortgage in retirement.”

For those who itemize their tax deductions, the argument to hold on to your mortgage is even more compelling. “My husband and I have a 2.75 percent fixed 15-year mortgage with a low balance. We could pay it off, but I am watching the tax benefit each spring when we prepare our taxes,” says Donna Skeels Cygan, a financial planner in Albuquerque and author of The Joy of Financial Security. “We itemize every year, so we get a tax benefit from the interest we pay and our investments are doing far better than the net after-tax mortgage rate. I understand the psychological benefit of paying off a mortgage before retiring, but weigh the financial and tax benefits more heavily in this situation."

Postpone a move?

Perhaps only downside of a low-rate mortgage is that it can act as an anchor, keeping you in the same home even if you want to move. Trading a 3 percent mortgage for a 7 percent mortgage is incredibly costly, after all. 

“Consider holding off on selling your home if buying your next home will be unaffordable at current rates,” says Rachael Burns, a certified financial planner with True Worth Financial Planning in Folsom, California. “If you must buy another home now, it certainly helps to put down as much as possible to reduce your loan size. However, if you don’t have the extra cash for a higher down payment, you may have to adjust your budget downward to account for the higher payments.”

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Does it make sense to withdraw a lump sum from a 401(k) or traditional IRA to avoid taking out a mortgage on a home purchase? The problem with that is that the tax hit on a large withdrawal could make the home purchase more expensive, says Patrick Carney, a CFP with Rodgers & Associates in Lancaster, Pennsylvania. He suggests spreading out retirement fund withdrawals over several years. “You could consider taking less from the IRA, taking out a mortgage and coming up with a plan to get the mortgage paid down over time so that there’s not a huge tax hit all in one year.”

You could also consider a 15-year mortgage, for which rates are lower, currently averaging 5.94 percent. Your payments would be higher, but you’d save money over the course of the mortgage.

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