I was recently having a conversation with a friend who is in a predicament with his mortgage. He has a low interest rate (3.5%) on his 30-year loan, which was taken out a few years ago. His original intent was to accelerate the payoff of this loan by making systematic additional payments each month, which he did for the first few years. However, now that he can get a higher interest rate on his cash (5%) than on his mortgage, he has decided to save more in cash and let it grow rather than paying off his mortgage early.

As interest rates have risen, this question has come up more frequently in our conversations with clients and friends. The chart below shows the 30-year mortgage rate since 2010:

 

In talking with my friend, my advice was to consider two key elements in the decision-making framework for managing debt:

1. The Math Equation – In this case, the math is clear. If you can earn a higher interest rate on your cash than you are paying on your debt, you’ll be better off not paying the debt off early. If you have the income to service the debt, and your monthly payments aren’t affecting your other financial goals, the math tells us “no” to paying off the debt early.
2. The Peace of Mind Equation – In our experience, there’s no doubt that paying off debt brings significant emotional benefits. Not owing money to anyone else is liberating. It removes a burden (emotionally and financially) and gives you more control over your financial life. This aspect of the equation should not be underestimated. Even in situations where the math favors not paying off debt early, we’ve recommended the opposite due to the emotional benefits of being debt-free. Understanding and acknowledging your values around money are important when determining how much this factor weighs in your personal situation.

The conclusion of my conversation was that, for now, my friend will continue saving cash instead of paying off his debt early. However, if interest rates on his savings decrease, he plans to resume accelerating his debt payoff and, with the cash he’s saved, will be able to make a large lump-sum payment.

How have you navigated the environment of rising interest rates?