A reader named John recently asked about the wisdom of buying I-Bonds vs. using that money to make mortgage pre-payments.
If I have a mortgage, would it not make sense to pre-pay it rather than buy I-Bonds? Or am I missing something?
This is an excellent question. In fact, it’s exactly the sort of thing that every mortgagee should ask themselves when deciding whether or not to invest any money they may have lying around.
If you look around, you’ll find tons of opinions on why paying off your mortgage early is a good or bad idea. Most of these hinge on risk aversion and the emotional benefits of paying off your mortgage vs. the (potential) mathematical benefits of investing with cheap money.
In the present case, I would argue that I-Bond interest rates are so low that it doesn’t make much sense buy them instead of pre-paying your mortgage. Of course, if inflation spikes, you might regret this decision.
I say this for several reasons.
First, and most obvious, if inflation spikes then I-Bond rates could reasonably exceed your mortgage rate, meaning that you’d be better of owning the bonds and paying your mortgage interest. But the longer it takes for this to happen, the bigger the differential needs to be.
Second, savings bonds are subject to annual purchase limits (currently $10k/year). Thus, if you forego your purchases now, you won’t be able to make up for it in the future. And if we get into a sustained period of high inflation, you may kick yourself for not having maximized your stash.
Third, mortgages themselves provide a degree of inflation protection. The reason for this is that you’re borrowing the money in today’s dollars but paying it back with tomorrow’s dollars. Thus, your payments get progressively cheaper as the value of the dollar shrinks due to inflation.
With all of this being said… When presented with a choice between buying savings bonds and pre-paying our mortgage, I would do the latter. In a heartbeat.
In our case, this is purely theoretical. We paid off our mortgage several years ago and we haven’t regretted this decision one bit.