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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?

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    Are you considering tax benefits or liability?
    – littleadv
    Oct 20, 2023 at 0:09
  • Do you have an Emergency Fund? If so, Harts answer is great. If not, consider splitting the $50k into “some” smaller CDs (depending on how large of an E-fund you decide on) and then put the rest against your mortgage.
    – RonJohn
    Oct 20, 2023 at 4:42
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    @keshlam Time left on mortgage is not relevant for a pay it off now vs 12-month CD comparison.
    – Hart CO
    Oct 21, 2023 at 18:33
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    @user26460 That's not correct, the reason the interest portion is higher earlier is because the balance is higher, you're always paying the interest rate on the remaining balance each month, so time is not a factor in this decision.
    – Hart CO
    Oct 21, 2023 at 18:37
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    @user26460 If it's pay it off now, or pay it off in one year when the CD matures (or just see what difference the two options make in a year), then the time left on the loan is immaterial. Balance and rate are the key variables. Similarly, the question of should you use extra money toward debt or earning interest does not depend on time, just the delta of the interest rates and things like tax implications/liquidity/etc. You can calculate the net difference of options over a period of time, but you don't need to consider time in order to make the decision about best use for each extra dollar.
    – Hart CO
    Oct 21, 2023 at 20:02

5 Answers 5

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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.

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    Also consider if money is at risk in a CD, or are they covered by deposit warranties? Whenever I see high guaranteed returns, I find it suspicious and wonder about risks or other catches.
    – gerrit
    Oct 20, 2023 at 8:39
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    @gerrit CD's are protected by FDIC insurance, the primary downside is an interest penalty if you withdraw early.
    – Hart CO
    Oct 20, 2023 at 14:47
  • @HartCO: FDIC insurance is certainly not universally applicable. Sometimes it's the equivalent credit union insurance, NCUA. The buyer should at least check that the CD is insured and not assume it. Also, creditworthiness of the borrower (financial institution) is important even with insurance, as if the insurance has to step in, payment will be significantly delayed, possibly much longer than the whole CD term, and no one will compensate you for the value of that time (interest you would have earned).
    – Ben Voigt
    Oct 20, 2023 at 21:51
  • what sort of cliffs do you mean?
    – njzk2
    Oct 21, 2023 at 19:27
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    @njzk2 There can be situations where earning an extra dollar costs you more than a dollar. Most of our tax code avoids this (marginal tax brackets, tax credits that have a tapered benefit as income increases), but there can be tax credits (EV credit might be one currently, but I'm not certain) where you get all/none based on income, in such cases someone that itemizes deductions might prefer to keep interest expense and avoid interest income to qualify for the tax credit.
    – Hart CO
    Oct 21, 2023 at 19:41
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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.

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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.

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    Finally, the correct answer. This site has a lot of these "investment or mortgage payoff" questions and I've never seen any of them answer it this way.
    – user26460
    Oct 21, 2023 at 2:19
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    Nice sheet, BTW. I've been working on a javascript html. It's still not ready for public scrutiny.
    – user26460
    Oct 21, 2023 at 2:20
  • @user26460: thanks, neither is that sheet really. I made it for myself to compare some things I was considering for my own strategies so it only partially works for mortgages with less than 30 year terms and is more of a scratch pad than user friendly interface heh.
    – jesse_b
    Oct 21, 2023 at 12:53
  • For those with Excel, there's a good loan amortization schedule template that's dynamic and easy to extend with rate comparisons and whatnot, can't seem to link to it but 'Loan amorization schedule' in the template search.
    – Hart CO
    Oct 21, 2023 at 20:09
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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%.

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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).

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  • Navy federal credit union currently has a 4.880% fixed rate CD that allows deposits. 15 month term. Kind of moot though because as you said you can get savings accounts at ~5% or at least 4.5% if you only want to bank with reputable banks.
    – jesse_b
    Oct 22, 2023 at 17:57
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    "The situation can't be as simple as you present it, even if you ignore taxes." It is. "I don't know of any CDs which allow monthly incremental deposits at the locked-in rate". Open a CD each month, of course. There's no law or rule against that.
    – RonJohn
    Oct 22, 2023 at 23:42
  • @RonJohn But there you can't easily lock in today's rate on a 12 months CD for a 4 month CD not opened and funded until 8 months from now.
    – jjanes
    Oct 23, 2023 at 0:22
  • That's so manifestly obvious that it's irrelevant. Hart, jesse_b and fred_dot_u's answers are great. This one... not so much.
    – RonJohn
    Oct 23, 2023 at 0:37

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