About a year ago we bought a house, paid in full with cash. Then I got a small mortgage as an inflation hedge and to invest for fun and profit (or loss.)
We used a chunk of the mortgage to fund moving expenses and to acquire all of the typical home accoutrements, put solar on our roof, and pay the medium-sized tax bill that comes with selling enough stock to pay cash for a house. The remainder I put back into the market as a lump sum.
It has now been one year out of thirty. Let’s check in on how this investment is doing.
Investing our Mortgage
Whether to have a mortgage or not is a topic of much debate amongst retirees of both the early and traditional type.
I found myself on the pro side of the argument because inflation was high and rates were low.
Our mortgage is $250,000 30-year fixed 2.75% interest. Payments are $1,020.60 monthly and I pay property taxes and insurance directly (no escrow.)
In September 2021 I invested $150,147 (60% of the mortgage proceeds) roughly in accordance with our asset allocation since I didn’t want to keep the excess funds lying around in cash.
- 450 shares of VTI @ 222.61 ($100,174.50)
- 475 shares of VXUS @ 63.10 ($29,972.50)
- I-bonds @ $20,000 ($20,000)
This is roughly a 75/25 US/International split on the equity allocation and a small contribution to bonds.
One of the plus sides of investing the mortgage vs holding in cash is that we receive regular dividends and interest.
We have now received 5 dividend distributions from VTI and VXUS and the monthly interest on the I-bonds.
Q32021 – $325.89
Q42021 – $386.64
Q12022 – $318.69
Q22022 – $337.10
Q32022 – $357.98
Q32021 – $169.34
Q42021 – $447.07
Q12022 – $ 47.69
Q22022 – $279.92
Q32022 – $133.19
Interest – $592 (through 10/1/2022) (currently paying 9.62%)
(Dividends used for current spending, I-bond interest added to principal.)
Unrealized Gains / Losses
One of the potential downsides of investing a mortgage is that the value of that investment changes with market values. Since markets are down our investment is down.
Recent prices from market close on September 22th, 2022.
Purchase price: $222.61
Recent price: $184.26
Purchase price: $63.10
Recent price: $46.69
Total gain/loss(%): -16.7%
Total gain/loss($): -$25,052.25
Another downside of investing the mortgage is we are making monthly mortgage payments. Although we get dividends and interest, we pay tax on those distributions.
Mortgage closing costs: -$30.37 (after all expenses and credits, the bank paid us to get a mortgage. Total scaled 60% of total to account for investing 60% of mortgage)
After holding the mortgage a year, it has cost us $4,374.90 in interest.
Pre-paid at closing: $260.19
Nov 2021 – $344.09
Dec 2021 – $343.46
Jan 2022 – $342.84
Feb 2022 – $342.22
Mar 2022 – $341.59
Apr 2022 – $340.96
May 2022 – $340.33
Jun 2022 – $339.70
Jul 2022 – $339.07
Aug 2022 – $338.45
Sep 2022 – $337.82
Oct 2022 – $337.19
2021 – $364.35 (effective tax rate: ~27.4%)
2022 through Q3 – $265.42 (effective tax rate: ~18%)
Per Vanguard, an estimated 97.57% of VTI dividends are qualified. For VXUS it is 73.76%.
Our 2021 tax rate for qualified dividends was ~25.8% (15% dividends, 3.8% NIIT, and ~7% California (scaled for part year residents.))
The tax rate for non-qualified dividends was higher, ~37.8% (12% ordinary, 15% dividends pushed out of 0% bracket, 3.8% NIIT, and ~7% CA.)
For 2022 our effective tax rate is 14% ACA tax and 4% CA, applied equally to qualified and non-qualified dividends. We will owe zero federal income tax.
We will get no tax benefit for the deduction of mortgage interest or property taxes.
Total expenses: $4,947.31
Additional gain/loss: -3.3%
Expenses minus income sucks another 1% out of total return.
Inflation is great for debt holders and was one of the motivating factors in getting a mortgage in the first place.
According to this inflation calculator, the $150,147 that I invested on 9/17/2021 is worth $10,186 LESS on 9/17/2022. Meanwhile my mortgage payment remains the same.
However, the value of my investments is down by an equal amount due to the same.
Was investing the mortgage a good idea?
Based on the 1 year return, no. Our investment is down significantly in nominal terms and even more in real terms.
A big factor in the return of any investment is the sequence of returns. Unfortunately the start of that sequence on this investment is not good at all.
Fortunately, this is a long-term investment. Ideally I will still hold these shares in 30 years.
Although this year expenses were greater than income (~$1500 more), as dividends increase and the interest portion of the mortgage payment decreases that will
reverse. Probably in year 5 to 7 plus or minus.
We got a small mortgage and invested much of the proceeds.
After one year, our investment is down 17.7%.
Cap loss (unrealized): -$25,052.25, -16.7%
Mortgage interest: $4,347.90, -2.9%
Dividends / Interest: $3,395.50, +2.3%
Taxes: $629.77, -0.4%
I have no idea what will happen in the short term.
Indeed short term volatility puts this all over the place.
What is your view on the equity property value? High inflation implies it should increase its value, but increased rates are technically lowering the value? Either way it doesn’t matter if you don’t sell, but do you think in the short term that a big jump in rates for new borrowers has impacted values?
As an outsider, when a bank does a fixed loan, how do US banks hedge their risk, since they’re earning 2% fixed on their loans but I assume paying rates of 6% now to get funding?
In my own market you get the double whammy of higher property prices and higher interest rates due to being floating. But it also meant prices never ran up like in the US because the market expected rates to go up and it adjust immediately…
Property prices will go down. The monthly payment on a 6% mortgage vs a 2.75% mortgage requires it.
According to Zillow (which is wildly over optimistic imho) our house price has fallen $100k from its peak so far, but is still up $50k over what we paid for it.
A bank does 2 things – they get funding at today’s rate for today’s mortgages. And then they sell it to the Macs, pushing the interest rate risk onto the government.
Thanks for that. So does the government then need to fund that potentially through taxes/printing?
Only if those agencies fail, as they did in 2008. Then there was a ~$200 billion bailout.
If a ton of people stop paying their mortgages things could go bad, but mortgage quality is 100x higher than in 2008 and people locked in low rates.
Thanks, it’s very interesting to me since we don’t have these fixed rates, so was wondering where the risk would lie.
Good that you found a house that you really like and would stay in for a long time.
We will likely be here until the kids finish high school in another 15-16 years
If I remember correctly, the US moved away from the type of adjustable rate mortgages popular in the rest of the world after the Great Depression. It is strange to me that the rest of the world still uses them
Appreciate this honest assessment.
Agreed. It would have been easy to see the numbers didn’t look good and skip posting this. Appreciate your keeping it real here.
keepin it real
Way real. 😁
How about tax loss harvesting the vti and vxus into something similar?
The opportunity is there, but I prefer not to cap loss harvest. I sell regularly to fund our everyday expenses and I want my basis to be as high as possible to minimize any impact on AGI.
Since our income is low, a $3k tax loss doesn’t help much. I just put this on my list of things to write about.
That said, I will have a $3k loss on 2022 taxes because I sold some funds in our taxable account to provide cash for Roth contributions. I still hold the same number of shares just more of them are in Roth accounts now.
Addendum: I was wrong
I am going to tax-loss harvest these shares.
Had you not commented, I would not have thought about doing this. Thank you!
I’d love to see an article on how the bank paid you to get a mortgage. I’ve had that happen with refis, but never with a new home purchase.
The mortgage market was crazy a year ago and I just played 6 companies off each other to get the best deal.
I wrote about this here: Getting a Mortgage Without a Job
I look forward to you writing about this. I have diligently tax loss harvested for years and it has been marginally helpful (though like you my taxable income is low). But now I’m sitting on sizable gains that do tend to “handcuff” me a bit. Hasn’t been a problem yet but could become one starting next year.
I started writing this post and realized I am an idiot.
Tax-loss harvesting is great and I was just overthinking it because of my years of successful gain harvesting.
That’s the beauty of the FIRE community. We all help each other. Your blog has helped me a TON on tax stuff in partic.
Appreciate the honest assessment. Too many blogs are unicorn glitter and gum drops. We made a similar conclusion, we considered moving, but we currently live in a home with a 15 yr mortgage at 2.0% interest, with only seven years left on the note, and couldn’t justify moving in this economic climate.
We definitely locked in the unicorn glitter and gum drop mortgage rates.
Can you count the mortgage interest as investment interest for offsetting taxes on your net investment income?
This is a more valuable interest deduction than mortgage interest because it reduces taxable investment income dollar for dollar with no need to surpass your standard deduction and personal exemption amounts.
It would be unconventional to claim this status for mortgage interest but it may technically meet the definition of investment interest if the mortgage was taken for the purpose of investing and you’re still holding the investment.
Potentially… I agree it would be unconventional. I’ll have to look into this some more, thanks for the idea!
I also appreciate seeing an honest assessment of a financial decision, rather than the ones that seem to indicate the writers have never made a wrong decision in their lives. All of us are in the same boat if we are in the market, unless some people have lucked into situations like buying put options that worked out. Best wishes and you will bounce back from this, hopefully after the midterms if they go in the direction the market prefers, a stalemated Federal apparatus.
My pleasure, sir. I have no shortage of stories about poor decisions
Great take, GCC. Agree on the tough timing, but this bet should easily pay off in the long run.
Curious if you’ve considered going with a more dividend-heavy allocation for this money to ensure it at least covers the interest payments? Seems like it wouldn’t be too challenging to build a portfolio of equities or real estate/syndications paying over 3% these days while still retaining some underlying appreciation upside.
Covering the interest payments isn’t a priority. I can pay them and it is not an issue.
Dividend heavy stocks tend to be in older / lower growth industries. They pay dividends rather than invest in new growth because they can’t grow faster with more investment. Over 30 years, that will produce lower returns.
I stick with the standard indexes for exactly the same reason.
At the end of the day you won’t know the “right” answer til you sell our house (or give it to your kids).
I think generally your strategy will work fine. There is potentially more downside though.
Thanks for the update
As my decision analysis prof said, you can’t judge a decision by the outcome. You made a solid bet based on available information (just like I did when I put home sale proceeds into the market in December). A down market was a possibility but not the most likely one.
Sounds like a good prof.
Jeremy, I don’t follow the accounting in your analysis. First of all, in testing the performance of your leveraged-investment-via-mortgage strategy, shouldn’t you be treating the entire amount of the loan proceeds ($250K, in your case) as being fully invested? I understand that you used some of the proceeds for cash expenses, but money is fungible and you otherwise would have paid those expenses using another source of funds. Correct me if I’m wrong, but I think the purpose of this exercise is to compare two scenarios to see which comes out ahead: one in which you took out the mortgage loan (and thereby allowed your investment portfolio to remain higher by an amount equal to the total amount of the loan, at the moment in time you took out the loan), and another in which you didn’t take out the mortgage loan (leaving the amount of the loan off both sides of your balance sheet). So I think at this point your leveraged investment performance is lagging even more than the numbers in your post suggest, but I would bet that the mortgage will turn out to have been a good idea after 30 years have passed.
I think of it this way. I took out a mortgage as part of buying a house.
Then I had a bunch of cash left over ($150k) and had to make a decision:
– pay down the mortgage by that amount
– do something else
I did something else (invested it) and am comparing the difference from that point.
Not sure if you already answered this but are those dividends reinvested or are you using the dividends for current expenses?
I-bond interest is added to principal
I’ll bet you look at this in Sept 2023 and it will be up a bit. The market and all risk assets are so beaten up right now, it’s not even fair to assess the damage!
Did you consider that you will get small amounts of foreign tax credit for dividends from VXUS, dollar for dollar offset on your federal taxes?
Yes, good point.
This doesn’t pan out for us. We get more federal tax credits than we pay in tax so any additional FTC is wasted. Itemizing and claiming the deduction instead doesn’t work either because our total itemized deductions is much less than the standard deduction.
Did you consider increase conversion amount from Traditional IRA to Roth to increase AGI to take fully advantage of available tax credits? Still got to watch out for the impact on ACA. But may be worthwhile to convert more while stocks are down and let it grow tax-free in Roth. Saving taxes on reduced share values.
I did, yeah. I’ll have to go back and look at it to refresh my memory, but…
I think with a small Roth conversion (~$5,000? Depends on Q4 income) I could maximize the CTC.
With a larger Roth conversion we could use some FTC. (We also qualify for saver’s credit but there is no way to actually utilize it.)
The marginal tax rate on this would be at least 21% (6% State, 15% ACA, 0% Federal.) It may also lose us cost-sharing subsidies on next year’s ACA (so higher deductibles, etc…)
21% is higher than I would like to pay on a conversion, but with a down market it could make sense in some cases. At today’s prices it is about the same as doing a conversion in early 2020 so it isn’t that exciting.
What I have done instead (so far) is make full contributions to my Roth solo-401k and his/her Roth IRAs ($32k?) Any foreign tax will be carried forward, or I could potentially amend 2021 return and carry back.
Update – I crunched some numbers. I think we will itemize deductions for California taxes and have a 2% – 4% marginal rate rather than 6%, for a total of 17-19%. Still probably not worth doing.
– What is your take on Traditional IRA balance growing faster than conversion amount if convert too little every year? I guess it’s a good problem to have. There are so many pieces of the puzzle to consider, AGI, taxes, time value of money, market value, ACA etc. You mentioned in your earlier article “GCC vs RMD” that “As of Dec 31st, 2014 the value of our tax-deferred accounts was ~$450k”. I would assumed it has grown a lot now.
– “Mind the Cap”: ACA repayment limitation.
Yeah tax deferred accounts are about 2x that now, in line with the market in general. We will pay some tax someday on those funds which is a minor thing.
– Trad IRA growing faster than conversion amount is going to be the normal case for most people. 7%+ average real growth is hard to keep up with.
I go through this in the series: Is Your 401k Too Big. The ACA kinda breaks this for early retirees because an extra 15% marginal tax rate on conversions means it is almost always better to wait.
– See: Obamacare Advanced Premium Tax Credit Repayment Limitation. It can be a good idea to do big Roth conversions or cap gain harvests in late December, sometimes, “accidentally”