High Inflation Can Reduce Your Mortgage Debt. Many Don’t Understand This
High inflation can be good for real estate
I have a friend who is 60 years old, no longer working, and has a second home in Porto, Portugal.
He wanted to amortize his fixed-rate mortgage from a Portuguese bank, which is due to expire in early 2023 so that he will be debt-free.
He asked me whether he should take out a new 10-year fixed-rate mortgage, which is much cheaper or buy shares that pay dividends for 145,000 euros.
He would probably get a good net return within those 10 years.
Also, the mortgage that has to be paid off might be lower than it is today because of inflation, and the value of the shares would not be lower than when they were bought.
I told him, that if you pay the mortgage as planned, you save on the interest on the house financing.
In the current low-interest-rate environment, a fixed-rate mortgage with a borrowed capital of 145,000 euros will cost about 1,500 euros to 2,000 euros per year, depending on bank conditions.
Now, you could invest that money in dividend stocks, and you would get a dividend yield of perhaps 3 to 4 percent a year, depending on the individual dividend payers.
Thanks to the yield differential between the mortgage interest paid and the expected dividend yield, you could be making a good deal 10 years from now.
But that’s no guarantee that your account will add up.
Because dividends are never guaranteed.
In bad years, dividends can be reduced or even canceled.
This would reduce your returns.
Also, you must pay tax on the dividends, but you can also deduct the mortgage interest from your taxes.
With a fixed-rate mortgage, the interest rate would at least be guaranteed. You would have a good chance of getting a positive return.
Stop speculating about other people’s money
Another question is what happens to the capital invested over the ten years.
After more than ten years of stock market booms and ultra-loose monetary policy, one cannot count on continued good weather in the stock markets over the next few years.
A more or less severe correction can occur at any time. Because many stocks are expensive.
Once interest rates rise, the stock market mood can cool down in an atom of a second.
Under certain circumstances, a longer bear market can also occur in the stock markets.
Since you don’t want to sell your dividend pearls, you can also live with accounting losses, as long as the dividend yield is correct. At least as long as the fixed-rate mortgage is foreclosed, i.e. at least ten years.
You would have to recalculate, but you run the risk that interest rates will be higher.
Should inflation rise after years of low or even negative inflation, which is not really predictable at the moment, you would have an advantage with mortgage debt.
In times of high inflation, you are well served if you have debt since inflation not only erodes your savings. But it actually reduces your debts.
So you would benefit twice over.
The argument that you shouldn’t speculate with someone else’s money goes against your plan.
Consider this: your mortgage debt is low, you have no other debts, and you are financially secure.
If you want to examine your project further, it is important that you are aware of the major investment risks you are taking on.
You should only implement your plans if you do not have sleepless nights because of a sharp drop in stock prices and are able to withstand the sharp price fluctuations that can occur at any time. Unless you have such a high-risk appetite, I would refrain from this path.
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