## What interest rate is needed to cover mortgage?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Topic Author
Tracker968
Posts: 248
Joined: Tue Feb 23, 2016 9:32 pm

### What interest rate is needed to cover mortgage?

I have a 3.25% construction loan (7 year ARM). I was planning on paying it off when I close on my new house but with interest rates going up I was wondering what rate I would need to get to cover my mortgage. I am not 100% clear on what is deductible and of course I would have to pay income tax on the interest earned. Do those two cancel each other out, meaning I need to get 3.25%?
Parkinglotracer
Posts: 1374
Joined: Fri Dec 20, 2019 3:49 am
Location: Upstate NY

### Re: What interest rate is needed to cover mortgage?

I’d say you would need to clear 3.25% after taxes if none of the loan payment is tax deductible. My guess is one won’t clear that return after taxes without taking extraordinary risk. If I had extra money I’d probably just put The extra money I had towards the loan as long as I didn’t have other debt or expect to need to borrow any other money in the near future. Good luck.
runninginvestor
Posts: 1532
Joined: Tue Sep 08, 2020 8:00 pm

### Re: What interest rate is needed to cover mortgage?

1-yr and 2-yr treasuries are just at your mortgage rate. You will owe income taxes, but not state taxes. If you're alone is big enough and you itemize your taxes, you might be able to deduct interest paid on your mortgage to lower your tax rate/effective yield on the mortgage. That would give you the flexibility to roll into higher rates in one or two years if they are available, more determined where you would want to place your money at that time.

Generally the calculate your taxable equivalent yield though, you would do the following:
tr = tax rate
r = interest rate (assume this is after taxes or taxes don't apply)
Taxable equivalent yield = r/(1-tr)

So a 3.25% rate with 22% tax rate would need an equivalent yield of .0325/(1-.22) =~ 3.7%

Risk-free treasuries aren't paying that yield yet. But they might in a year*. And your 3.25% rate might be slightly last if you are able to the deduct any of that interest.

*They also might be a lower, and if they go down enough, it might be attractive to refinance your construction loan to a lower overall rate.
Outer Marker
Posts: 2653
Joined: Sun Mar 08, 2009 8:01 am

### Re: What interest rate is needed to cover mortgage?

Tracker968 wrote: Fri Aug 05, 2022 9:56 pm I have a 3.25% construction loan (7 year ARM). I was planning on paying it off when I close on my new house but with interest rates going up I was wondering what rate I would need to get to cover my mortgage. I am not 100% clear on what is deductible and of course I would have to pay income tax on the interest earned. Do those two cancel each other out, meaning I need to get 3.25%?
So, if i understand correctly, you have a current construction loan at 3.25%, and are considering rolling it into a new mortgage, once the house is complete, correct? If you have the options to keep the loan, as it sounds like you do, that would be preferable since current rates are much higher. This would appear to count a purchase-money interest and would be fully deductable (up to the \$750k limit), but you might want to double-check with an accountant. https://www.investopedia.com/terms/c/co ... rtgage.asp

It would generally not be advantageous to refi into a new loan greater than 3.25% - but there is the advantage of security of a long-term fixed loan, as rates could go higher. I'd be inclined to take the gamble. There's usually a cap on ARMs, and you could always pay it down faster if rates are higher.
Topic Author
Tracker968
Posts: 248
Joined: Tue Feb 23, 2016 9:32 pm

### Re: What interest rate is needed to cover mortgage?

Yes I can keep the construction loan for 7 years. I could pay it off at closing but I'm considering keeping it. If interest rates go up enough to cover it then I don't see a reason to pay it off.
I guess the tax on the interest I earn would offset the tax on the interest I pay. So I need to get 3.25 or in more.
willthrill81
Posts: 32250
Joined: Thu Jan 26, 2017 3:17 pm
Location: USA

### Re: What interest rate is needed to cover mortgage?

Tracker968 wrote: Sun Aug 07, 2022 10:23 pm Yes I can keep the construction loan for 7 years. I could pay it off at closing but I'm considering keeping it. If interest rates go up enough to cover it then I don't see a reason to pay it off.
I guess the tax on the interest I earn would offset the tax on the interest I pay. So I need to get 3.25 or in more.
Yes, the 3.25% rate on the mortgage will very likely not be deductible, meaning that it's an after-tax expense. 5 year Treasuries are yielding 2.95% right now, and 10 year Treasuries are yielding 2.82%, but both are before taxes.

At this point, it's speculation as to whether Treasury yields will rise enough to yield 3.25% after taxes. If you have the funds to pay off the loan at closing and would otherwise buy something like Treasuries with those funds, I'd pay off the loan instead.
Posts: 818
Joined: Sun Sep 12, 2021 4:23 am

### Re: What interest rate is needed to cover mortgage?

If you live in CA, VCLAX is paying 2.9% completely tax free and has a duration of 7 years, which eliminates interest rate risk when matched to your construction loan.
lakpr
Posts: 8253
Joined: Fri Mar 18, 2011 9:59 am

### Re: What interest rate is needed to cover mortgage?

CletusCaddy wrote: Sun Aug 07, 2022 10:44 pm If you live in CA, VCLAX is paying 2.9% completely tax free and has a duration of 7 years, which eliminates interest rate risk when matched to your construction loan.
Last I looked, interest paid on construction loans is not tax deductible. Even if the OP lives in California and adopts your suggestion, it should be with the full understanding that he is paying a 0.35% premium for the liquidity.

Then again, given that he cannot get a mortgage loan anywhere close to 3.25% even on 7/1 ARMs, to the extent that money intended to pay off the construction loan would be directed to reduce the mortgage balance, keeping the loan is worth it
Posts: 818
Joined: Sun Sep 12, 2021 4:23 am

### Re: What interest rate is needed to cover mortgage?

lakpr wrote: Sun Aug 07, 2022 10:58 pm
CletusCaddy wrote: Sun Aug 07, 2022 10:44 pm If you live in CA, VCLAX is paying 2.9% completely tax free and has a duration of 7 years, which eliminates interest rate risk when matched to your construction loan.
Last I looked, interest paid on construction loans is not tax deductible. Even if the OP lives in California and adopts your suggestion, it should be with the full understanding that he is paying a 0.35% premium for the liquidity.

Then again, given that he cannot get a mortgage loan anywhere close to 3.25% even on 7/1 ARMs, to the extent that money intended to pay off the construction loan would be directed to reduce the mortgage balance, keeping the loan is worth it
OP should look again at mortgages. With \$1M in assets moved to Schwab he can get 3.5% on a 10/6 ARM

https://www.schwab.com/mortgages
Outer Marker
Posts: 2653
Joined: Sun Mar 08, 2009 8:01 am

### Re: What interest rate is needed to cover mortgage?

lakpr wrote: Sun Aug 07, 2022 10:58 pm Last I looked, interest paid on construction loans is not tax deductible.
That's incorrect. Once OP moves into the house, the construction loan becomes just like any other purchase-money mortgage. (IRS pub. 936, p. 10). Further, up to 24 months of pre-occupancy construction loan debt can be deducted. (p. 4). https://www.irs.gov/pub/irs-pdf/p936.pdf.