Don’t Pay Off Your Mortgage, Immunize it!
Should you lock-in high yields on fixed income assets and immunize your mortgage? A mortgage immunization strategy uses fixed income assets to pay off future mortgage debts. If you have a low interest rate mortgage, you can lock-in higher interest rates on high quality fixed income assets now and earn more on these investments than the interest cost on your mortgage. This is a better strategy than paying off the mortgage. Retirees often think it is wise to pay off their home mortgage early. But this will reduce their long-term net worth and financial security if their mortgage interest cost is low (under 3.5%).
WESCAP encouraged clients to refinance mortgages in September 2020, at a time when mortgage interest rates were near historic lows. Many homeowners refinanced during this period, locking in low rates for their 30-year fixed mortgages. However, mortgage rates have increased above 7% with the Federal Reserve’s interest rate hikes this past year. While this is bad for new home purchases and refinancing, it provides an opportunistic risk management strategy for existing low-interest mortgage borrowers.
A simple example may suffice. Let us assume that an existing mortgage of $500,000 has an interest rate of 3%. The annualized interest cost is therefore $15,000. A 10-year Treasury bond is currently paying 4.1%. If one invests $500,000 in this Treasury bond, then the annual earnings would be $20,500. In this case, not paying off the mortgage and investing in a Treasury note instead, increases earnings by $5,500/year.
A mortgage also has principal payments, which reduces the mortgage balance owed over time. Therefore, owning a series of Treasury securities with varying maturities is best to match the ever-shrinking mortgage balance to the Treasury assets. So different amounts of 2-year, 5-year, 7-year, 10-year and longer Treasury notes and bonds may be optimal.
Note that an immunization strategy may result in lower returns than owning other assets besides Treasury securities. U.S. government Treasury securities offer the ultimate principal and income security, but often at the cost of lower returns than other assets.
A fully immunized mortgage would not be optimal if the present value of mortgage liabilities is nearly equivalent to your current portfolio value. The degree of immunization is situational and depends on an individual’s financial goals, in addition to their balance of investment assets to liabilities.
While a complete immunization strategy can be followed, a hybrid strategy of owning Treasury securities along with other fixed income and equity assets may yield a higher long-term return and ultimately boost financial security.
WESCAP will be happy to review your mortgage and decide if an immunization or hybrid immunization strategy is warranted over the alternative of paying off the mortgage early.
As always, please feel free to contact WESCAP at (818)563-5170 if you have any questions about these items or if you would like to schedule a time to talk about your specific situation.