Should I Pay Off My Mortgage? Part 5

We can make educated guesses based on history

Before we leave the story of Jim and Sue, there is one more angle to consider in any mortgage payoff analysis. The bane of most investors, especially retirees, is the increase in the cost of living, also known as the reduction in purchasing power, or inflation, for short. Over the last 80 or so years, inflation has averaged 3%. What might inflation be over the next 35 years, which is Jim and Sue’s combined life expectancy?

Many financial pundits see inflation looming on the horizon. They contend that the falling dollar, the ever-expanding budget deficit, the Fed’s bailout plans, and the huge government total debt portend rising inflation. Rather than guess what inflation is going to look like, I base my recommendations on the long-term 3% average inflation rate. So what does this have to do with mortgages?

Remember that the 4.7% 15-year mortgage is a fixed or flat rate. As the years go by, with 3% inflation, the monthly payment is made with cheaper and cheaper dollars. Meanwhile, Jim and Sue are still working for the next 10 years, with salaries hopefully increasing at least at the rate of inflation. Upon retirement, their Social Security payments should also have yearly cost-of-living increases. Their house will likely appreciate in value, based on typical real estate value behavior during times of high inflation. Rates on CDs and new bonds will increase, and certain stocks should also keep up with inflation.

In short, their income from work and investments should steadily increase, while their mortgage payments remain flat for 15 years. Fixed-rate mortgages are simply one of the best inflation hedges around.

For Jim and Sue, this angle tips the scales in favor of refinancing. Meanwhile, they can invest their $200,000 windfall in low-cost equity index funds, I Bonds, Treasuries, inflation-protected bonds, or whatever else their diversified and thoughtful asset allocation model suggests. They should come out ahead over the next 15 years.

Can I be absolutely certain of this? No. But in view of historic investment returns, historic inflation rates, and our current low income tax rates, this favorable outcome is more likely than not. No one can accurately predict the future, but we can make educated guesses based on history. If you know of a reliably better way, let’s talk.


By Deborah Hoskins, JD, CFP
The Wise and the Wary Blog