The price does rise on flexible-rate mortgages. Fixed-rate mortgages, however, lock in rates for the entire term of the loan--in many cases, 15 or 30 years, and it's fixed-rate mortgages that Michael is talking about. For instance, my mortgage is 30-year at 3.5% interest--I purposely refinanced when rates were low--while my home-equity line has a flexible interest rate that will continue to rise. Obviously, I would pay off the home-equity line first because of the higher interest rate, but also because the interest rate will continue to rise. Once I do so, I'll have to make a strategic decision about my mortgage--with such cheap debt, does it make sense to pay off early in a high interest-rate environment.lukethedrifter wrote:I was following. Until i wasn’t. You’re saying an interest rate rise causes bonds to become more valuable to the issuer. Then why wouldn’t the price rise?Michael wrote:For most households I think the bonds question is most likely relevant if you ever have the opportunity to pay down a mortgage early. Conceptually, a mortgage is a bond you issue (The question above assumes the opposite - you're the buyer not the issuer). Therefore, when interest rates rise your mortgage becomes more valuable.If interest rates rise, what will typically happen to bond prices? Rise, fall, stay the same, or is there no relationship?
For example, let's say you have a 100k mortgage at 4% interest and low money markets are paying 1% interest. If you're trying to decide where to place an extra $500 a month a guaranteed 3% (4%-1%) return might appeal to you*. However, if interest rates increase and money markets start paying 5% you'd be crazy paying down a 4% mortgage instead of investing in the money market. Investing in the money market gives you 1% better returns than paying off the mortgage early. As you can see in a high interest rate environment your mortgage is a valuable piece of debt and your mortgage company would love for you to pay it off early because they'll be able to get better returns elsewhere.
*For simplicity I'm not going to discuss taxes, liquidity concerns or alternative investments like stock index funds.
We haven't been in a high interest-rate environment for a very long time. For instance, I kept most of my money in a savings account in the 1980's when I was a grad student, and even with the paltry sums I earned then (stipends of $5500 and $6000 a year), I would net $500 a year in interest. It would be nice to earn that kind of return on savings again--but only if I get rid of high-priced debt at the same time.