Borrowing at one rate (mortgage) and lending at another (bonds)

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dandan14
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Borrowing at one rate (mortgage) and lending at another (bonds)

Post by dandan14 » Mon Oct 07, 2019 8:27 am

Hey folks --
I love the way Allan Roth puts it -- that it makes no sense to borrow at 4% on a mortgage and lend at 2% on a bond.
So before we take out this next mortgage, I want to think through this -- because it gets slightly more complicated.

Mortgage:
The builder incentivizes using their lender by giving $12k toward closing costs. That isn't "real" money, because their loans are overpriced. But I figure it is still worth about $7k. That isn't money that I can get as a discount on the house.

So if I use that -- and no more -- to buy down the rate, I'll probably be at 2.75% -- maybe 2.6, depending on where rates go over the next few weeks.
With other closing costs related to the lender (not counting the ones that I would have if I bought in cash), the effective rate over 5 years will likely come out to 2.8 or 2.9%.
(Excel can tell me exactly, once I have the exact numbers.)

Fixed Income:

Navy Federal has 5 year CDs at 3% right now. That's hard to beat.

Taxes:
Unless something changes, I don't expect to itemize. So that 2.75% mortgage really is 2.75% after tax.
Right now, I have my tax sheltered accounts full of other stuff. I could move these CDs into an IRA, but then I have to move something else out. So my inclination is to say that I should compare it to what 3% is in the after tax world. Since we are moving to a no-state-income-tax state, let's assume 24%. So 3% becomes 2.28%.

So if I look at this with a 5 year view, the math seems to say just pay cash.

As an alternative, what if I bought no points. Maybe even take negative points and see if they will allow me to apply the $12k toward things like prepaid taxes, transfer fees, title insurance, etc. (My guess is they won't.) That would get the house in my name and pay the fees -- after which I could pay the house off after x months.


Thoughts?

dziuniek
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Re: Borrowing at one rate (mortgage) and lending at another (bonds)

Post by dziuniek » Mon Oct 07, 2019 8:57 am

Bonds return does not come from it's coupon payment only.

What's the yield on Vanguard Total Bond Market versus what it returned year-to-date?

Additionally, I look at bonds as a form of insurance/hedge against a drop in stocks and real estate.

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whodidntante
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Re: Borrowing at one rate (mortgage) and lending at another (bonds)

Post by whodidntante » Mon Oct 07, 2019 9:11 am

dziuniek wrote:
Mon Oct 07, 2019 8:57 am
Bonds return does not come from it's coupon payment only.
Another way to say this is bonds have risk. I agree you can take risk and get lucky, but one should not count on luck. The risk might show up and thwart your plan.

A direct CD or Treasury note held to maturity is easier to compare because the outcome is certain, just like the mortgage.
dziuniek wrote:
Mon Oct 07, 2019 8:57 am

What's the yield on Vanguard Total Bond Market versus what it returned year-to-date?
Do you really believe bond returns YTD are relevant? Because I don't. You can't buy YTD bond returns, you can only buy future returns.
dziuniek wrote:
Mon Oct 07, 2019 8:57 am

Additionally, I look at bonds as a form of insurance/hedge against a drop in stocks and real estate.
Depends on the bond. Corporates tend to sink along with equities if things get rough. If you buy Treasuries, your yield will be lower, and thus a larger yield gap vs the mortgage. I don't believe there has been a reliable negative correlation of bonds to equities, but you can probably justify that there has been no correlation.

What bonds do provide you is the ability to spend the money on other things, though you might be doing so at a loss if you spend the money while your bonds are down.

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dandan14
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Re: Borrowing at one rate (mortgage) and lending at another (bonds)

Post by dandan14 » Mon Oct 07, 2019 9:55 am

whodidntante wrote:
Mon Oct 07, 2019 9:11 am

A direct CD or Treasury note held to maturity is easier to compare because the outcome is certain, just like the mortgage.
That's my thinking as well. That's why I used 3% at NavyFed as my benchmark.

dcw213
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Re: Borrowing at one rate (mortgage) and lending at another (bonds)

Post by dcw213 » Mon Oct 07, 2019 10:00 am

I just took on a mortgage and went through the same thought process. I could have paid cash but it would have nearly wiped out all my taxable assets beyond my emergency fund. This was too precarious a situation for me with a new home and 2 kids. Funny you say Navy Fed, as I loaded up on 5 year CDs a few months ago when they were at 3.5%. After all tax implications, I am paying a small premium (about 0.35%) for borrowing the funds. Worth it to me to maintain the liquidity. Now, if I had an extra million laying around I probably would pay cash but few are in that position.

Admiral
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Re: Borrowing at one rate (mortgage) and lending at another (bonds)

Post by Admiral » Mon Oct 07, 2019 10:32 am

Ignore the bond returns vs mortgage rate argument: the rates are so close it may be a wash.

Here's the pertinent question:

Why would you want to lock up all or most of your available cash in a single, non-diversified asset?

Someone is willing to give you a fixed loan at 2.75%, when inflation is 1.5-2%. Take it without a second thought and invest your cash however you want, as long as you're properly diversified.

deikel
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Re: Borrowing at one rate (mortgage) and lending at another (bonds)

Post by deikel » Mon Oct 07, 2019 11:04 am

I would agree with previous posters

If you make the comparison between mortgage and bonds or CDs or savings accounts - it really 'just' becomes a question of liquidity and the marginal money you will either benefit or pay for one or the other option . In your example, it looks like your penalty is 0.5% for drawing the mortgage at the benefit of having cash in hand

But really, when you truly leverage the mortgage, you should compare to the average return of that money in your chosen asset allocation (which should be higher, assuming you have some stock allocation). In that case you probably gain money from the deal, certainly over the long term. Your OP is unclear if this is a short 5/1 ARM or a 15 or 30 yr fixed.

If it is a longer term fixed, you can also consider the mortgage a kind of inflation protection.

I think under current conditions almost all aspects point to having the mortgage and the cash in hand (other then you have so much cash anyway, that the mortgage would just be an unnecessary complication (another account) not worth dealing with).
Everything you read in this post is my personal opinion. If you disagree with this disclaimer, please un-read the text immediately and destroy any copy or remembrance of it.

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dandan14
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Re: Borrowing at one rate (mortgage) and lending at another (bonds)

Post by dandan14 » Mon Oct 07, 2019 2:36 pm

Admiral wrote:
Mon Oct 07, 2019 10:32 am
Ignore the bond returns vs mortgage rate argument: the rates are so close it may be a wash.

Here's the pertinent question:

Why would you want to lock up all or most of your available cash in a single, non-diversified asset?

Someone is willing to give you a fixed loan at 2.75%, when inflation is 1.5-2%. Take it without a second thought and invest your cash however you want, as long as you're properly diversified.
I didn't say I was wanting to lock up all of my available cash. I suggested that I might want to use some of the fixed income portion of my portfolio to buy the house.

However, here are some things I've thought about thanks to this thread.
  • It's so close as to almost not matter.
  • Liquidity in a house is difficult. Requires a month of refinancing and some closing costs.

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