This is correct (using after-tax yields) when the yield curve is inverted (short-term rates higher than long-term rates), as it is now. If you can earn 4% after-tax on your money-market fund, and pay 3.5% after-tax on your mortgage, you earn more interest than you pay. If money-market yields drop, you can pay off the mortgage then.No need to calculate anything. As long as the savings account interest rate is greater than the mortgage interest rate you are coming out ahead with savings.
If the yield curve is not inverted, the correct comparison is bonds of the appropriate duration; you could use a bond fund for comparison.
f you are considering paying down your mortgage, the comparison is a zero-coupon bond of the same term as the mortgage. For example, if you sell a 10-year bond yielding 4% to pay down a 10-year mortgage at 4%, you will reduce the final year's payment by exactly what the bond would be worth then, so this is break-even.
If you are considering paying off your mortgage, the comparison is a bond portfolio with the same duration as the mortgage. The duration of a mortgage is slightly less than half its term, because payments of equal dollar amounts in the later years have a lower present value. For example, if you have 10 years left on your 4% mortgage, you could buy a portfolio of bonds maturing in 1-10 years which would cover the payments every year. If this bond portfolio yields 4%, you would break even; the present value of the bond portfolio would be equal to the mortgage balance.
For example, in 2020, I had 9 years left on my 2.625% mortgage, with interest fully deductible for an after-tax rate of 1.78%. I could have bought a municipal-bond fund; a fund with a 4.5-year duration yielded 1.24% at that time, 1.14% after state tax. Therefore, it was better for me to pay off the mortgage than to buy municipal bonds. (I didn't actually sell munis to pay off the mortgage; I sold stock in my taxable account for a capital loss, and instead of buying back stock there, I moved an equal dollar amount from bonds to stock in my employer plan to keep the stock-market exposure.)
If you effectively sold bonds in tax-deferred, why use munis as the alternative point of comparison rather than some kind of discounted yield on a bond held in tax-deferred?
You could do something like discount it by the future expected rate at time of withdrawal?
Statistics: Posted by muffins14 — Thu Sep 19, 2024 10:41 pm