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I am confused about the mortgage rates in APR vs CD rates that I could invest in [US].

I have a mortgage loan that I got with 2.875 APR. I could pay that off or invest that money in a CD with rate of 5.5 (I think that's called APY?)

I thought I should be able to invest that loan money into CD with higher rate but when I performed calculations, there is not much difference.

Assume I have $50,000 loan that I could pay off (2.875 rate) which I could invest in CD with 5.5 rate for 12 months, could anyone please tell me what would be the correct calculations?

chicks
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zadane
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5 Answers5

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Assume I have $50,000 loan that I could pay off (2.875 rate) which I could invest in CD with 5.5 rate for 12 months, could anyone please tell me what would be the correct calculations? Thanks!

Mortgages are (typically) simple interest loans, and CD's compound (usually, if not always) and will therefore usually advertise APY (yield instead of rate). That sets these two up for easy comparison, 5.5% - 2.875% = 2.625%. Ignoring taxes, you'd come out ahead $1,312.50 (50,000 * 0.02625) after 12 months by opening a 12-month CD instead of paying off your mortgage.

There can be complicating factors, how much tax will you pay on the interest income? Does the mortgage interest reduce your taxes? Does the extra income push you over any tax cliffs? You'd want to factor those things in so you can compare effective rate of your debt vs effective rate on a CD, but it's unlikely any of those considerations would wipe away the 2.625% advantage of the CD.

Hart CO
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I think you have a decided advantage with the limited duration of 12 months on the CD. The difference between the rates is minor, but not insignificant, especially when you consider the return on investment for the CD.

When the CD comes due, you'll have that much more money available to apply to the mortgage but you'll have possibly lost far less in interest on the mortgage during the same period.

As an anecdote, a family member decided to use her investments to erase her mortgage. Her health has since deteriorated and the lack of mortgage payments has made managing her finance all the easier. She has lost her post-retirement income along with her health and the cessation of payments means balancing the expenses are achievable.

fred_dot_u
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I actually made a google sheet comparing basically what you are talking about a while ago.

The sheet isn't perfect and there are some missing variables but you can sort of see what math is involved in your calculation.

Most importantly needed is how many years are left on your loan? If you owe $50k within the next year paying it off all at once will save you around $1437.5 where investing that money for 1 year at 5.5% will gain you $2750, a net gain of $1312.5. This isn't nothing but it might not be significant enough to outweigh the peace of mind that comes with not being in debt.

Now more likely you owe $50k and still have several years left on your loan, lets assume 10 years. If you pay your loan normally over the next 10 years you will spend $7,590.89 in interest. If you instead put that $50k into a CD at 5.5% for the next 10 years (assuming you can get a 10 year fixed interest rate or the interest rates remain at 5.5% for 10 years) you will gain $35,407.22 in that time.

jesse_b
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I am a no debt guy, and with the current market situation I would invest in CDs, t-bills or bonds rather than pay off my mortgage. Buying those instruments through a broker like Fidelity is easy and are typically offered in 1K increments for a variety of maturities.

Currently my favorite is short term, lower rated bonds. They are yielding close to 7%.

Pete B.
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The situation can't be as simple as you present it, even if you ignore taxes.

If you pay off the mortgage completely, you don't need to make any more payments on it. If you don't pay of the mortgage and instead put the money in the CD, then you need to keep paying on the mortgage. But where would that money come from, since your initial funds now are tied up in a CD?

Presumably you have a stream of income, like from a job, with which to make the payments. But then if you do pay off the mortgage, what do you do with that portion of the stream of income which would otherwise go to the mortgage? Accumulate it into a checking account paying no interest? A savings account paying 4.8%? Make intermediate monthly deposits into the CD earning 5.5%? (I don't know of any CDs which allow monthly incremental deposits at the locked-in rate).

jjanes
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