A couple years 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.

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 two years 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. With inflation and mortgage rates where they are in Dec 2023, I would take the opposite position.

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.

In the subsequent 2.x years, US markets are up and global markets are down.

Allocation changes

With inflation down and short-term interest rates up, I redeemed half of the i-bond position on 10/3/2023, and am holding that cash ($11,208) in my brokerage core account earning 5.0%. The redemption will add $1,208 to our 2023 taxable income. Because I held these bonds less than 5 years, I lost 3 months of interest when redeeming ($94.69) at an effective interest rate of 3.38%.

I will redeem the other half on 1/1/2024 for $11,404, and buy new ibonds at a higher fixed rate (1.3% vs 0%.) I will similarly lose 3 months of interest upon redemption ($94.69 at a 3.38% rate.)

Income

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 2.5 years of dividend distributions from VTI and VXUS and the monthly interest on the I-bonds.

VTI Dividends – $3,680.78
Q32021 – $325.89
Q42021 – $386.64
Q12022 – $318.69
Q22022 – $337.10
Q32022 – $357.98
Q42022 – $418.73
Q12023 – $353.79
Q22023 – $371.92
Q32023 – $359.28
Q42023 – $450.77

VXUS Dividends – $2,269.31
Q32021 – $169.34
Q42021 – $447.07
Q12022 – $ 47.69
Q22022 – $279.92
Q32022 – $133.19
Q42022 – $298.73
Q12023 – $57.24
Q22023 – $293.55
Q32023 – $140.22
Q42023 – $402.37

I-bonds
Interest – $2,750.01 (through 1/1/2024) (ibonds currently paying 6.48% and cash paying 5%)

Total: $8.700.10
Gain: 5.8%

(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. Until the rise in stock prices in December 2023 our investment was down.

Recent prices from market close on December 29th, 2023.

VTI
Purchase price: $222.61
Recent price: $237.22
Gain/Loss(%): +6.6%
Gain/Loss($): +$6,574.50

VXUS
Purchase price: $63.10
Recent price: $57.96
Gain/Loss(%): -8.1%
Gain/Loss($): -$2,441.50

I-bonds
Gain/Loss: 0%

Total gain/loss(%): +2.8%
Total gain/loss($): +$4,133

Expenses

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 (well, they increase our taxable income…)

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)

Mortgage interest

After holding the mortgage for 2+ years, it has cost us $9,329.07 in interest.

Total: $9,329.07
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
Nov 2022 – $336.56
Dec 2022 – $335.92
Jan 2023 – $335.29
Feb 2023 – $334.65
Mar 2023 – $334.01
Apr 2023 – $333.37
May 2023 – $332.73
Jun 2023 – $332.09
Jul 2023 – $331.45
Aug 2023 – $330.80
Sep 2023 – $330.16
Oct 2023 – $329.51
Nov 2023 – $328.86
Dec 2023 – $328.21
Jan 2024 – $327.55

Taxes

Total: $364.35
2021 – $364.35 (effective tax rate: ~27.4%)
2022 – $0
2023 – $0 projected

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.
However we paid no tax on the income from investing our mortgage. (I originally thought I would pay some tax on 2022 dividends, but they were all offset by tax credits I otherwise wouldn’t have received)

Similarly I expect to pay zero tax in 2023.

We get no federal tax benefit for the deduction of mortgage interest or property taxes, and although we do get a larger deduction on California taxes our tax burden is already $0.

Total expenses: $9,663.05
Additional gain/loss: -6.4%

Expenses exceed income, reducing total return by 0.7%.

Inflation

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 $17,329 LESS on 12/15/2023, a reduction of 11.5%. Meanwhile my mortgage payment remains the same.

This doesn’t help much today, as our investments have a similarly reduced purchasing power, but in 10+ years I will probably appreciate having a healthy chunk of inflation front-ended.

A Chart, Just Because

Historically, dividend income has increased over time. The SP500 dividend in 2023 was almost 2x what it was when I quit work in 2012, for example.

In the short term, with minor dividend growth and the natural walk down the amortization table (where interest is a smaller part of each subsequent mortgage payment), income could exceed the interest expense by the end of 2024.

Assuming the dividend grows at only a 3% rate (half of growth rate in the decade pre-covid), income will likely exceed the entire payment a few years before the mortgage is satisfied (see chart.) At a 4% growth rate (not shown) that happens a full 10 years earlier.

Summary

We got a small mortgage ($150,147) and invested the proceeds.

After 2.x years, our investment is up $3,170, +2.1%, which is not great but better than the 1-year return.

Cap gain (unrealized): +4,133, +2.8%
Mortgage interest: $9,329, -6.2%
Dividends / Interest: $8,700, +5.8%
Taxes: $364.35, -0.2%
Inflation reduction in mortgage value: -$17,329, 11.5%
Principal paid to date: $7,500

If I sold everything and paid off the mortgage immediately, today, we would receive $14,383.
($7,500 in principal reduction + $4,133 in unrealized gains on stock sales + $2,750 of i-bond accumulated interest (already counted as part of “income”))

What happens next? Will our investments go up or down? Will this be a profitable venture or one of my many terrible ideas? Dunno.

But I do know it is very likely that in 2024 investment income will exceed mortgage interest for the first time and that gap will grow over time.