Should I start paying down my mortgage?

This is a question I’m really asking myself a lot these days. And the reason for that is simple: the interest rate on my mortgage increased from 2.68% to 4.96% in just the last 6 weeks.

This means that it nearly doubled and that my monthly gross payment (principal + interest) increased by approximately 20%. This is really a lot and it makes me wonder whether I should continue to invest my monthly savings into dividend growth stocks.

Historically I have always considered an interest rate of more than 4% as high-interest-bearing debt which should be considered to be paid off first. This is definitely the case right now!

Hence, in this article, I will share with you my current situation and why I’m exposed to such a sudden interest rate increase. After that, I will explain to you my thought process to manage this situation and lastly, I will share with you my next steps.

So grab your tea or coffee and let’s get started!

Mortgage rates in Poland vs Western Europe

I bought my first apartment in the Netherlands at a 7-year fixed mortgage rate of 4.85% back in 2007. Unfortunately, we experienced one of the biggest housing crashes ever just a few months after my initial purchase.

In response, the ECB and the Dutch Central Bank drastically reduced their interest rates which allowed consumer banks to provide cheap financing in an effort to get people into spending money again.

This was a really great time for new homeowners because they were able to lock in very cheap mortgages rates in the decade thereafter. Actually, some people have been able to lock in a 30-year fixed mortgage rate below 2%. This is extremely cheap from a historical perspective and I salute everyone who was able to benefit from such deals.

Unfortunately, this is not how the mortgage system works in Poland. It’s nearly impossible to get a 30-year fixed mortgage rate deal with any of the banks. Actually, I don’t know any bank offering that.

WIBOR

On the contrary, the vast majority of Polish homeowners have their mortgage rate connected to the 3-months WIBOR (Warsaw Interbank Offer Rate). Hence, our mortgage rates are the result of a simple formula:

3M WIBOR + Rate negotiated with the bank

In my case, I was able to negotiate a 1.9% interest rate with the bank because at the time of signing the contract I was in a weak negotiation position. Simply said, being self-employed and being a foreigner increases the risks significantly according to a bank’s risk-management standards.

In practice, this means that I was paying a 2.46% interest rate (1.9% + 0.56% 3m Wibor) on my mortgage just 2 months ago, which for Polish standards is really low.

Though truth to be told, some banks do offer a 5-year fixed mortgage interest rate. However, there was only 1 bank offering this to me at a very unfavorable rate (5+%). Honestly, I know only 1 person with such a deal out of all the people I know and this person regretted it a lot!

Having said that, for most people in Poland it means that their mortgage rates change every 3 months so some volatility is to be expected. But what we’ve seen is the Polish government intervening to fight inflation which is currently 11% year-over-year.

As a result, have a look at the 3-month WIBOR chart below:

3M WIBOR rate development

So what you can see here is an increase from 0.24% in October 2021 to 5.57% today. This is a very rapid increase in just 6 months and this hasn’t happened yet since Poland joined the European Union in 2004.

But let’s get back to my personal situation. I mentioned in the opening line of this article that my current mortgage rate is 4.96%. Unfortunately, this is still valid for just a few weeks, because soon it will be bumped to at least 7.5% based on today’s 3M Wibor rate.

In practice, this means that my monthly mortgage payment (principal downpayment + interest) has increased by approximately 30% when it hits a 7.5% interest rate.

Forget about increasing fuel and energy prices. Those are peanuts compared to what we’re experiencing in Poland with mortgage interest rates.

What to do in this new reality?

This question brings us back to the title of this blog: should I start paying down my mortgage debt?

Actually, the majority of you have indicated to just start paying down the mortgage in a recent Twitter poll:

Should I start paying down my mortgage twitter poll
Twitter Poll

Also my first intuitive reaction to this capital allocation decision is to start paying down the mortgage instead of investing in the stock market. I mean, we are really talking about a 5%-risk-free rate of return for years to come. Or maybe we aren’t?

This is where my analytical mind starts to take over. Are we really talking here about a 20-year risk-free rate of return?

Actually not! As mentioned earlier, my mortgage is tied to the 3-months WIBOR. In other words, the mortgage rate could as well easily drop again towards 3% or 4% over the next few months. In such a case my return would be quite mediocre for the capital deployed right now.

But there’s more to my story which is important to be aware of.

Currently, I have a loan-to-value ratio of approximately 20% to 25% depending on fluctuating market values. This means that I have already ~75% of my cash locked up in non-income generating bricks and mortar.

I neither need to worry from a monthly expense ratio point of view. Our total monthly mortgage expense has traditionally been about 12% of total expenses. In other words, an increase towards a 14% expense ratio is really not an issue for us.

These 3 reasons are why I’m currently leaning towards NOT additionally paying down my mortgage.

I’m also quite convinced that I’m able to generate a 10% annual ROI based on the capital that I deploy into dividend stocks. A large part of that comes from dividend income and reinvesting those dividends. Another part comes from price appreciation by investing in undervalued or fairly valued dividend growth stocks.

Conclusion

The current mortgage rate is really high right now and this is not something I have ever experienced in my life so far. Usually, I would’ve started paying down the mortgage at these levels, because I do consider anything above 4% as high-interest-bearing debt.

However, I am in a very luxurious position where we can easily pay the monthly bill. Hence, it’s not like we have the water standing at our lips (Dutch proverb).

That’s why I feel that I can be a bit riskier in my approach and still see this debt as a kind of leverage to generate outsized returns (10% vs 5%).

Of course, this thinking can always change based on changing market situations or based on further learnings.

That’s why I’m really curious to hear from you!

Are you experiencing a similar situation? And what would you do in my case? Do you think that I’m making a wise decision?

Just let me know in the comment section below 👇

Yours Truly,

European Dividend Growth Investor


Disclaimer

I’m not a certified financial planner/advisor nor a certified financial analyst nor an economist nor a CPA nor an accountant nor a lawyer. I’m not a finance professional through formal education. I’m a person who believes and takes pride in a sense of freedom, satisfaction, fulfillment and empowerment that I get from being financially competent and being conscious managing my personal money. The contents on this blog are for informational and entertainment purposes only and does not constitute financial, accounting, or legal advice. I can’t promise that the information shared on my blog is appropriate for you or anyone else. By reading this blog, you agree to hold me harmless from any ramifications, financial or otherwise, that occur to you as a result of acting on information provided on this blog.

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European DGI

It's my desire to retire early via Dividend Growth Investing as a passive income stream. This is not easy and especially when living in Europe. That's why I started this blog and share my journey: to give you a European perspective.
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