Is it Better to Pay off Your Mortgage or Buy Gold?
The term “debt” usually has a negative connotation, and in most cases is counterproductive to living a life of freedom and security. For many people, debt can be an albatross around one’s neck and cause them to be debt slaves. People like Dave Ramsey have made millions of dollars by developing a simple plan to become debt free (he also is against investing in gold). Simple doesn’t always necessarily mean easy, as it requires discipline and the shedding of bad habits, which is difficult to do. They say that it takes 21 days to break a habit, which on the surface appears to be doable, but can be challenging when the time comes to implement the plan.
In general, we believe that everyone should strive to become as financially independent as possible. Furthermore, we believe that most, if not all, credit card debt and debt on depreciating assets, such as vehicles, is bad debt. Furthermore, the interest rates on many of these credit cards or loans are in the double digits, which means that you’re paying substantially more for whatever you decide to purchase than you might realize.
At present, some financial experts are advocating that you strive to become debt free as soon as possible, as we may be heading into a rocky economic environment. Issues, such as the collapse of Silicon Valley Bank and Signature Bank, have resulted in a lack of confidence in the banking sector. First Republic Bank was also on the verge of collapse and was acquired by J.P. Morgan, which will further cast doubt on the banking sector, resulting in even larger withdrawals and lack of stability in the market.
The banking sector may be the catalyst for the next economic collapse, but is not the only reason for concern, as inflation remains stubbornly high. Furthermore, job layoffs have begun, credit card balances are at their highest levels ever, auto loan defaults are increasing, the commercial property sector is starting to crash, residential foreclosures are increasing, supply chain issues continue to persist, de-dollarization is gaining steam, war drums continue to beat, we have a debt ceiling crisis on our hands, and annual deficits continue to be north of $1 trillion. Not to mention, the stock market, bond market and the residential real estate markets all appear to be in a bubble, which can pop at any time.
Needless to say, these are uncertain times.
Those with means realize that they need to be well positioned for the future and are working on reducing, if not eliminating their debt, and becoming more liquid. In many cases, we’ve talked to people who are considering paying off their mortgages to become completely debt free. On the surface, eliminating any and all debt sounds like a prudent approach, but is it the best strategy for you? In this article, we’re going to talk about the pros and cons of paying off a mortgage as opposed to investing in gold to see which is the better option.
At present, 30 year mortgage rates are approximately 6.9%. This is a substantial increase from the lows set in December of 2020 of 2.5% or less. Of course, one reason why we’re in a housing market bubble and home ownership has become unaffordable for most Americans is because of the artificially low interest rates created by the Federal Reserve’s intervention in the market.
As you may recall, in response to Covid-19, the Federal Reserve added trillions of dollars to their balance sheet by purchasing bonds to suppress interest rates to generate economic activity. As usual, they were successful, as this stoked demand in the housing sector, among other areas of the economy. Individuals who previously were only able to afford a moderately priced home could now afford to make the monthly payments on a substantially more expensive home. No longer was a $500,000 home out of reach for most Americans. Unfortunately, most people don’t consider the price of the house and an exit plan – they only focus on what they can afford on a monthly basis.
Today, homeowners are stuck between a rock and a hard place. Demand for residential real estate has abated, as a 7% 30-year mortgage interest rate no longer makes a $500,000 home affordable for most Americans. The substantial increase in interest rates, in some cases, has caused mortgage payments to nearly double. Furthermore, current homeowners are reluctant to sell, especially those that are locked in a low interest mortgage, as the next home they purchase will be at a much higher interest rate.
Thus far, we’ve discussed a general overview of the market, which is important groundwork to lay before we delve into the topic of paying off your mortgage versus investing in physical gold coins or bullion.
Benefits vs. Drawbacks of Paying off a Mortgage
Before continuing, let’s take a step back and discuss the benefits and drawbacks of paying off a mortgage, as it’s important to consider the pros and cons of each before making such a large financial decision.
The benefits of paying off a mortgage are probably obvious for most of our readers, but it probably bears repeating. Paying off a mortgage, assuming all your other debts have been paid off, gives you a sense of financial freedom. No longer do you have a large monthly payment deducted from your bank account. This provides you with a debt-free asset, frees up more monthly discretionary income and probably most importantly, from a psychological perspective, puts you that much closer to financial independence.
However, there are potential drawbacks to paying off a mortgage. The most obvious is that it drains your savings, which you may need to tap in the future in the event of a job loss or unexpected medical condition. Furthermore, this will likely reduce if not eliminate the six to twelve months of living expenses that you’ve set aside for emergencies. Remember – liquidity is very important during uncertain times, so you don’t want to put yourself in an illiquid situation by having all your net worth tied up in a house.
Paying off your mortgage also effectively locks in your investment. Let’s delve into this issue a bit further. Let’s say that you recently bought a $500,000 house at the top of market, took out a 30-year fixed conventional loan and made a down payment of 20% to avoid private mortgage insurance (PMI). Assuming that your purchase was relatively recent, you have approximately $400,000 remaining on your mortgage. To become debt-free, you liquidate some of your investment holdings or use your savings and pay off the remaining balance.
While the feeling of not having a mortgage payment is certainly nice, you’ve just made a $500,000 investment at the top of market. Considering that the housing market is in a bubble (prices have increased 50% or more over the past couple of years), you’ve effectively bought at the market high. If we have a large decline in the housing market, which is quite possible – especially as foreclosures rise and home prices revert to the mean, you may find yourself with a $300,000 house in a couple of years, which means you’ve lost 40% on your investment.
While we don’t necessarily advocate dropping your keys in the mail to the lender when you’re underwater, many people did just that during the last housing crisis. There were also programs introduced during the Great Recession, which allowed homeowners to arrange a short sale through their lender with the difference between the sale price and outstanding mortgage forgiven by the lender. A short sale arrangement was also beneficial in that it didn’t affect the homeowners’ credit as a foreclosure would. While we prefer that the government stay out of the free market, this was a lifeline for many individuals who found themselves in a difficult situation.
Is Your Mortgage an Asset or Liability?
At the end of the day, it’s important to differentiate between an asset and a liability. Let’s delve into this topic a bit further.
Let’s say for example, you were one of the lucky individuals that secured a 2.5% interest rate on a 30-year mortgage rate toward the end of 2020. We’ve actually heard of some folks obtaining sub-2% interest rates, so a 2.5% interest rate was certainly within reach of many homebuyers.
From our perspective, a 2.5% mortgage rate should be viewed as an asset as opposed to a liability.
But how could you ever view debt as an asset? We’ll explain.
At present, the “official” inflation rate is 5%, which is down from the highs set in mid-2022 of 9.1%. While the Federal Reserve has been increasing rates over the past year, they are close to their terminal rate. What does that mean? It essentially means that the Federal Reserve has hit a ceiling in terms of how high they can raise rates without plunging the economy into a severe recession.
Let’s assume that the Fed can raise rates another .5% – 1% before shifting toward a more neutral stance. They can’t raise interest rates much further, as the federal government won’t be able to service their debt payments with a national debt approaching $32 trillion (at the time of writing this article)
See the current national debt amount in real time below.
This small increase likely won’t have much of an impact on the inflation rate, which means that higher inflation rates are here to stay for the foreseeable future. The more likely scenario is that the Federal Reserve will change strategies or “pivot” within the next year when we’re in a recession and resume their bond purchases. An increase in bond purchases will likely cause inflation rates to increase from current levels.
However, we’ll give them the benefit of the doubt, and assume that they’ll be able to incrementally raise interest rates without plunging the economy into a recession. In my opinion, the best-case scenario is that we see inflation drop by another percent, but likely no further than this. In other words, don’t expect inflation to drop much below 4% under any scenario short of another severe recession or depression.
In this environment, your 2.5% mortgage rate should be considered an asset as opposed to a liability. This is because your mortgage rate remains the same while inflation increases. This is similar to the government’s approach of inflating away our debt by the creation of money. In other words, they reduce the real value of debt by paying off debt with money that is worth less. We’ll provide you with an example to better illustrate our point.
Let’s say that you lived in Zimbabwe and were able to secure a fixed rate mortgage before inflation began to rise in 2000’s. In this case, it was quite easy to pay off your mortgage with depreciating currency, as the government issued notes as large as $100 trillion. Obviously, in this case, your fixed mortgage was an asset.
While we’re not necessarily predicting hyperinflation in the U.S., our point is that a low fixed rate mortgage can be viewed as a liability – especially if it’s below the prevailing inflation rate. On the other hand, a mortgage rate of 7% when inflation is at 5% may be viewed as a liability. This is because a guaranteed rate of return of 7% on your money by paying off your mortgage looks decent relative to an inflation rate that is below this rate.
Let’s give you another example. Let’s say you have a credit card with a 20% interest rate. You’re much better off paying off your credit card and effectively earning a 20% return on your money than putting your money in a savings account yielding 1% while your debt continues to grow.
As is usually the case, the decision isn’t that clear cut, as there are other factors to take into consideration.
Mortgage Interest Deduction
On the surface, most people would jump at a guaranteed risk-free return of 7% on their money, but what you may be forgetting is that you’re able to deduct interest payments from your taxable income. With a standard deduction, this may not be much of a factor, but if you itemize your deductions, and are able to deduct your mortgage interest payment, this could potentially push your effective rate below 7%. Considering that most of your mortgage payment goes toward interest as opposed to principal – at least in the earlier years of a mortgage, it’s possible that you could have a large deduction on your hands.
While we’re not mortgage or tax experts, this is an issue worth discussing with your accountant, as a nominal interest rate of 7% could be reduced to an effective interest rate at or below the prevailing inflation rate. In this scenario, maintaining a 7% mortgage as opposed to paying off your mortgage may be the better strategy.
On the other hand, we strongly discourage people from taking out home equity lines and using that money to buy gold and silver or to otherwise invest the proceeds. The only caveat is if you’re able to secure such a low rate that you’re able to invest your money in a risk-free asset at a higher rate. This is using leverage, which is always dangerous. While it may work to your benefit, more times than not, people end up falling short of their investment goals, thereby reducing their home equity and further adding to their debt liabilities.
Returns in Excess of Your Interest Payments
Ultimately, when viewing whether to pay off your mortgage or not, you need to take into consideration other investments that will provide real-adjusted returns above and beyond your mortgage rate. With a mortgage rate of 2.5%, this is fairly easy to do – especially considering that a portion of the mortgage interest payments made during the year are likely tax deductible.
However, nominal returns aren’t a good barometer, as most investments are taxable, so your real returns will be less than the stated rate. Historically, certificates of deposit (CD’s) and short-term treasury bills or bonds have been considered risk-free investments close to it. With a current national average of 1.68% on a 1-year CD, this isn’t a viable option.
At the moment, the highest yielding U.S. treasury bill rate is a three-month bill at approximately 5%. Assuming a 25% – 33% tax rate, your real return on a three-month treasury bill would be 3.35 – 3.75%. If you’re one of the lucky few to have a 2.5% mortgage rate, buying a short-term treasury appears to be preferable to paying off your mortgage.
However, as we saw in 2022, bonds do carry interest rate risk. In fact, the bond market as a whole had its worst performing year on record with a loss of approximately 13%. Short-term duration bonds fared better with an average loss of .1% in 2022, but this is far from the positive returns expected by most bond investors.
Gold as an Investment or Savings Option
This brings us to gold as an investing or savings option. From 1971 to 2022, gold had an average return of approximately 7.8%. Following the strength in the gold market this year, the average return since 1971 may be closer to 8%. Why do we use 1971 as the starting point to determine long-term returns? Is it an arbitrary date used to bolster long-term returns? Not at all. 1971 is significant because this is when President Nixon took the U.S. off the gold standard. Until 1971, the price of gold traded at a fixed price of approximately $35. 1971 is significant in that it marks the beginning of a free-floating gold price, allowing the market to determine an appropriate price.
While there have been plenty of issues of the 50+ years that have contributed to a rise in gold prices, never in our history have we experienced the number and potential magnitude of issues that we are experiencing today. All the issues that we identified in our opening paragraph, including others, are positive for gold. While none of us are cheering for a worldwide economic collapse, the likelihood of this occurring increases by the day as we fail to address the fundamental and structural issues with our monetary and fiscal policies.
If the nominal return of gold has been 8% over the past 52 years under more ideal circumstances, there’s a good possibility that it will continue to perform well for the foreseeable future. Gold is not only one of the best ways to hedge against inflation, but also protects against a depreciating currency and rises to the occasion during financial, geopolitical or economic crises. If we assume for purposes of our discussion that gold will continue to return on average 8% a year, at the time you liquidate your position, you’ll receive a real annualized return (after taxes) of approximately 5.5% – 6%, far outpacing the guaranteed rate of return you would receive by paying off your mortgage.
One other factor to consider is that this doesn’t take into consideration the push by state governments to recognize gold and silver as legal tender. According to this source, 23 states have moved to recognize gold and silver as legal tender, which means that they can be used the same as cash without state taxes due on any profit you may have realized. Furthermore, the state of Texas has recently introduced a gold backed digital currency bill, which would allow the state currency to trade alongside or in lieu of Federal Reserve Notes. This bill was introduced in part in response to a proposed Central Bank Digital Currency (CBDC).
None of the above considers the potential end of the Petro dollar, the de-dollarization by foreign governments and discussions of a gold-backed currency by China or Russia or a group of nations, such as the BRICS nations. Any adoption of a gold-backed currency, whether domestically (even if just in Texas) or by a foreign nation or group of nations, will cause gold prices to skyrocket.
While we don’t anticipate that the U.S. will voluntarily adopt a gold-backed currency, at some point, it may be forced to if the dollar loses its position as the world’s reserve currency and is no longer widely used in trade. Speaking of trade, the dollar share of global reserves was as high as 73% as recently as 2001, but only accounted for 47% of reserves in 2022. There’s a clear trend, and it’s going the wrong way.
While we’re not in the prediction business, all signs point to a strong gold market in the foreseeable future. That doesn’t necessarily mean that it will always increase in value. It simply means that you can expect it to perform as an inflation hedge, at the very least, with the possibility of much higher returns.
One last quick note regarding tax implications before we wrap up. If your state has passed legal tender laws or is expected to do so, this will reduce your overall tax burden if and/or when you liquidate your position. Furthermore, if the federal government passes legislation making gold legal tender, or goes back on a gold standard, profits realized on the sale of gold will also be exempt from federal taxes. In other words, that 8% return that we’ve been discussing will be a real return, which makes gold an even more attractive option than paying off your mortgage.
While on the surface, the question of if you should pay off your mortgage or invest the proceeds in gold appears to be straightforward, there’s much more to it than meets the eye. It’s important to consider the mortgage rate on your home. If you were fortunate enough to obtain a loan or refinance in late 2020, then you likely have a mortgage rate in the mid 2% range.
A fixed 2.5% mortgage rate should be viewed as an asset – not a liability. This is below the current inflation rate, and will likely continue to be, as the Federal Reserve has hiked rates about as far as they can go without plunging the economy into a recession. Keep in mind that inflation allows you to pay off your mortgage with a depreciating currency. Recall our extreme example of Zimbabwe.
The decision of paying off a higher mortgage rate loan isn’t so clear cut. Even then, recall that if you itemize your tax deductions, you may be able to reduce your effective rate (after deducting interest payments) to a level where it makes sense to maintain your mortgage. A 7% mortgage rate without tax deductions creates more of a dilemma, but even then, you run the risk of losing money on your investment if you pay off your loan when the drop in residential real estate prices inevitably occurs.
Another important point to remember is that your tax-adjusted returns should be higher than the guaranteed return that you receive by paying off your mortgage. Even at a higher interest rate, the case can be made for an investment in gold. While we would never advocate taking out a home equity loan to invest in precious metals, over the long run, an investment in gold will likely exceed any guaranteed returns you’ll receive by paying off your mortgage.
If you have discretionary income and have made the decision that an investment in gold coins or bullion is the best course of action for you and your financial future, the experts at Atlanta Gold & Coin Buyers can help. We can recommend products that best serve your needs and help to put you on the path to financial freedom.
Reach out to us today at 404-236-9744 to see why we’re more than just your average coin dealer. We look forward to hearing from you and earning your business!