Are Mortgages Tax and Financial Losers?

A Couple Asks If Mortgages Are Tax and Financial Losers:

The Facts

Married couple: Age: 30
Jack’s earnings: $37,500
Sue’s earnings: $37,500

Combined 401K savings: $75,000
Regular Assets: $90,000
Housing: Own $450,000 home

Jack and Sue are considering taking out a mortgage on their home and investing in bonds. They want to reap the alleged tax breaks from having a mortgage and they are also keen on investing the equity in their home — but doing so safely since the mortgage repayment is a for-sure obligation.

The couple sets up their current case as MaxiFi’s Base Plan. They set up an alternative profile that entails their borrowing 80 percent on their house for 30 years (taking out a 30-year mortgage on their house for 80 percent of its value) and investing the proceeds in 30-year Treasury bonds. To their surprise, they learn that this move would represent a massive financial mistake for two reasons. First, they would borrow at a far higher rate than the rate at which they can safely invest. Second, the move would raise, not lower their current and future taxes.

The Base Case

Jack and Sue are 30 and married. They both work as accountants, making $37,500 a year. The couple plans to work until they are 67. At this point they will also begin their Social Security benefits and withdraw from their retirement accounts. Each year, Jack and Sue contribute 3 percent of their labor earnings to their respective 401k accounts, which their employers match. The couple owns a home in Massachusetts worth $450,000 and pays $4,500 annually in property taxes. Every year, they also pay $2,250 for homeowner’s insurance and another $2,250 for maintenance. The couple currently has $90,000 in regular assets, which is invested in 30-year Treasury bonds yielding 2.545 percent.


In the alternative plan, Jack and Sue take out a 30-year mortgage of $360,000 at a 4.125 percent interest rate. They Invest the $360,000 in the same 30-year bonds yielding 2.54 percent. What happens to their lifetime discretionary spending? It falls 3.93 percent — from $2,453,242 to $2,360,512, i.e., by $92,730! That’s more than they earn in a year! What about their lifetime taxes? They’d rise by roughly 2 percent. Hence, the major reason taking out a mortgage is a gigantic financial mistake is that Jack and Sue have to pay a higher rate on their borrowing than they can earn on their saving.

Households with Higher Incomes

Next, consider four other couples that are identical to Jack and Sue except that all their inputs, including their labor earnings, are multiples of those Jack and Sue. First up is Tony and Debby. Their combined yearly labor earnings are $100,000. The couple owns a home worth $600,000 and has $120,000 in regular assets. If they mortgage their home and invest the proceeds, their lifetime discretionary spending falls by 3.64 percent – from $3,120,576 to $3,010,867 or $109,709. Again, this exceeds their annual earnings even ignoring taxes on those earnings. Next, Rob and Wendy. Together they make $150,000 per year and own a home worth $900,000. They have $180,000 in regular assets. Their lifetime discretionary spending falls by 3.30 percent from borrowing and investment -- $4,332,890 to $4,194,567. The decline is $138,323, which is less than a year’s earnings but not much less.

The next couple, Tim and Katie, jointly make $250,000 every year and own a home worth $1,500,000. Before taking out a mortgage they have $300,000 worth of regular assets. Their lifetime discretionary spending falls by 4.10 percent from $6,235,275 to $5,989,559, i.e., by $245,716.

Lastly, Mark and Liz. This couple makes $500,000 annually and owns a home worth $3,000,000. They have $600,000 with of regular assets. Mortgaging their home produces a 6.10 percent drop
in their lifetime discretionary spending from $9,511,153 to $8,964,333 i.e., by $546,820.

Your Best Investment — Pay Off Your Mortgage

This case study has a key lesson. If you have a mortgage that you can afford to pay off, you stand to earn a bundle by doing so. And this increase in lifetime discretionary spending, which, as we’ve
seen, could equal a year or more of earnings, depending on the household’s circumstances, is completely safe.