If you're a homeowner looking to live for free, buying Treasury bonds today likely will. After an aggressive hike in the Fed Funds rate since the beginning of 2022, three-month treasury bills are yielding over 3.3% and one-year treasury bills are yielding over 4%.
Once you've got your housing expenses under control, life becomes much easier. One of the obvious benefits of owning a house with a fixed-rate mortgage is that your mortgage stays the same as rents and inflation increases
I'm assuming most homeowners with a mortgage refinanced before mortgage rates started going up in 2022. For two years, homeowners with mortgages had the ability to refinance a 30-year fixed rate for under 3%.
In addition, the vast majority of people who took out adjustable rate mortgages and 15-year fixed mortgages locked in rates at under 3%. In fact, 90% of mortgages have an interest rate of under 5% and 55% of mortgages are under 4%. Therefore, a good number of homeowners can live for free if they buy Treasury bonds today.
Buying U.S. Treasury Bonds To Live For Free
In my case, I purchased a primary residence in 2020 with a 7/1 ARM at 2.125%. Therefore, I could use whatever cash I have to buy a 10-year Treasury bond at ~3.5% to cover my mortgage interest and early an additional 1.4% risk free.
Let's say my mortgage balance is $1 million and I have $200,000 in cash. I can cover 20% of my mortgage balance by buying $200,000 worth of 10-year Treasury bonds. To completely eliminate risk, I would have to hold the Treasury bond until maturity.
Of course, I could always just pay down extra principal for a guaranteed 2.125% return. But buying a 10-year Treasury bond with a 3.5% yield after a large decline is enticing. Not only can I guarantee myself a 1.4% higher gross annual return if I hold until maturity, I also have the potential to sell the bond for a profit if rates decline.
For most homeowners with a mortgage, we should consider allocating more of our idle cash to risk-free assets such as Treasury bonds and I-Bonds as part of our regular asset allocation strategy. Even though we are still earning a negative real interest rate due to higher inflation, the returns are all relative.
It was a no-brainer to buy $10,000 worth of I Bonds at the end of 2021 for a guaranteed 7.14% return through April. And it's a no-brainer to buy another $10,000 worth of I-Bonds this year with an even higher guaranteed return today.
Never decline free money!
Calculating Taxes To Live For Free With Treasury Bonds
Everybody will calculate their taxes to figure out their ultimate cost benefit. Using gross interest rates is an easy way to compare differentials. However, let's go through a scenario after calculating taxes thanks to commenter feedback. Please keep them coming.
Interest income from Treasury securities is subject to federal income tax but exempt from state and local taxes. Meanwhile, the interest on a mortgage up to $750,000 is deductible. If you live in a high state tax state like California, Connecticut, New York, and New Jersey, buying Treasury bonds is relatively more attractive.
Let's say you lock in a 30-year fixed mortgage rate at 2.5%. If you pay a 22% marginal federal income tax rate, your effective mortgage rate is 1.95% assuming no AMT and you can deduct all the mortgage interest.
Now let's say you buy a 10-year Treasury bond yielding 3.5%. If you pay a marginal 22% federal income tax rate on 3.5%, then you will earn a net 2.73%, which is still 0.78% higher than your effective mortgage rate of 1.95%. Awesome!
Of course, if you can pay a lower tax rate on the Treasury bond yield and or deduct a greater percentage of the mortgage interest, your “living for free” spread will increase and vice versa. Everybody's income and tax rates are different, so please run the numbers to calculate your true benefit.
Buying Bonds In The Past To Try And Live Cheaper
Back in 2017, I sold a rental property because I no longer wanted to spend any time managing it. It wasn't because I was bearish on the real estate market. It was because I had become a new father. The tenants were driving me nuts and there were also a lot of upcoming maintenance issues.
I reinvested 40% of the proceeds into stocks, 30% of the proceeds in real estate crowdfunding, and 30% of the proceeds in AA-rate California municipal bonds. The municipal bond investments were my way of locking in some low-risk and tax-free passive income while 70% of the proceeds sought higher returns.
The blended interest rate on the individual municipal bonds was about 3% tax-free, while my primary mortgage rate at the time was 2.875%. I had a 5/1 ARM that I ultimately refinanced to a 7/1 ARM in 2019 at 2.625% with all the fees baked in. (This is a different house from the one above with a lower 7/1 ARM rate.)
The returns were steady until the bond market rout in 2022. For example, the California Municipal Bond Fund (CMF), which I don't own, is down about 8% YTD.
However, my municipal bonds have done its job of paying an annual 3% tax-free coupon (~4.2% gross yield). My plan has always been to hold the municipal bonds until maturity for steady passive income.
I just want to point out there is risk in even low-risk investments. 2022 will turn out to be the worst year for bond investors in history. Therefore, stay vigilant in your capital allocation strategy.
If you hold a bond to maturity, you won't lose money on your principal. But if you hold a bond fund, there is no maturity and you are subject to the ups and downs. Here's a detailed post on how to buy treasury bonds, especially now that yields are at decade plus highs.
A Psychological Win For Homeowners
The reality is, most consumers don't have enough cash to instantly pay off their mortgage. It's why home buyers took out mortgages in the first place! Therefore, this idea of living for free by buying Treasury bonds is mostly an academic exercise.
However, even if you don't have enough cash to completely pay off our mortgage or invest in Treasury bonds, you are still benefitting. Just having the optionality of being able to earn a higher risk-free return than the cost of our mortgage debt improves consumer confidence.
It's kind of like having the option to earn more money at a new firm for many years if you want because you're pals with the CEO. Or maybe it's like having a trust fund ready to bail you out if you fail at an entrepreneurial endeavor. But you elect not to tap it out of pride.
When consumers have more options, consumers tend to spend more money and live less stressful lives. Therefore, this ability to arbitrage and live for free is a bullish indicator for the economy. But the public needs to realize this fact first.
Homeowners have already benefitted by a tremendous rise in property values since 2020. Now it's time to let things cool and enjoy cheaper, lower-risk living. This way, you're always winning!
Another Potential Way To Live For Free Higher On The Risk Curve
Earning a guaranteed interest rate from a Treasury bond is one way to live for free. However, if you are willing to go up the risk curve, you may want to consider following my Buy Utility, Rent Luxury (BURL) real estate investing rule to live for free as well.
The concept of BURL is simple. Invest in lower-cost areas of the country (buy utility) that generate higher cap rates (rental yields). Then use the higher rental yields you get from say, San Antonio, Texas, to pay for your rent in a city like New York (rent luxury), with much lower cap rates. We're talking ~8% versus ~3% cap rates.
One of the easiest ways to BURL is invest in a private real estate fund from the likes of Fundrise, my favorite real estate investing platform. Fundrise, with $3.2+ billion in assets, focuses on buying single-family and multi-family rental properties in the Sunbelt. Although there are no guarantees, Fundrise investors have consistently provided positive returns during difficult times.
Before, it was hard for individual investors to invest in real estate across the country and conduct such an arbitrage. But thanks to technology and the buildout of such platforms, now anybody can. I've been following my BURL strategy since 2016. I've invested $810,000 so far in private real estate investments and I plan to continue investing in the future.
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It is a sort of double counting to consider a mortgage interest tax deduction in full without discounting the standard deduction that you get for doing nothing.
If you have $30,000 in interest for a given year, and your standard deduction is $25,900, your net benefit of itemizing is only on the $4,100. If you are in the 22% bracket, that means a 5% interest rate is reduced by 0.15% for an effective rate of 4.85%. It doesn’t reduce the rate by 22%, but instead by 3%.
Can I start a sole proprietor business merely to invest in options like Fundrise (or REITs)?
why would anyone pay down a mortgage of 3% when Ibonds are at 9%
Aren’t you capped at $10k max per person per I bond?
Sam and readers,
I think you can buy iBonds in a revocable trust. The process seems complicated. Anyone interested in writing about it?
Not sure it’s worth writing a whole post about it. We can just get back to our estate planning lawyers and ask. I would think so.
Again, I want folks to focus on capital allocation maximization. I Bond rate or the online savings account rate. I prefer the former.
No sure I completely understand this article. If I have a 400k mortgage at under 2.85%, are you saying take 400k of investable assets out of stocks and buy 10-year treasury bonds, thereby off-setting my interest payments? And buying treasury bonds right now is a preferable investment than using that 400k to place ion other investments?
No. I would use some of the cash and cash flow you have earning way less. Don’t create a tax liability by selling assets unless you have to.
Hi Sam,
I’m a long time subscriber and always appreciate the financial information and opinions you share. I agree with your positive longterm outlook for real estate in the Heartland and have been invested in the Heartland fund with Fundrise. Is this the fund that you are invested when you refer to investing in the Heartland?
I was also looking to do this strategy. There was also some very low risk corporate bonds (BBB) available around 4%. That would be a 2% spead over my borrowings.
But I’ll wait a few more months. Rates are still going up, so I don’t want to lock in too early. I may even wait until 2023 to see what the Fed is doing after a few more hikes.
For now, I’m still 100% equity. I feel relatively safe, even though there is a lot of volatility in the markets. I look at all my single positions, and they all look very cheap. So, I feel relatively safe holding stocks at the actual price level. Not risk-free, but almost risk-free.
Don’t think the average BBB corporate bond has done well this year.
Glad you feel good with your 100% equity position.
You are right. With interest rates rising, all bonds are doing absolutely terrible this year. That’s why I wanted to wait a little bit more before I buy.
The advantage of BBB corporate bonds is you can get an additional 1% or 2% return over government bonds. If you buy short-term maturities (less than 3 years) and hold to maturity, your interest rate risk is greatly reduced. And in addition, assuming you make sure the company has enough money to pay the bond in full, the credit risk is also greatly reduced because there is less chances of adverse event happening over a shorter term time frame.
So they become inreasingly interesting. But, like I said, it may be still too early.
Hi Sam! Long-time reader. This may be a bit of technicality, but should we consider marginal tax bracket when comparing US Treasury 10-YR Bond vs mortgage rates.
I believe interest from US Treasury is taxable at federal level, hence the after-tax yield may be lower than one’s mortgage rate. Even though I have a low mortgage rate (2.125%), finding bonds with competitive after-tax yield may not be as straightforward.
This is what I have been looking to see in the comments. It is literally the worst advice I have ever read. By the time you factor in taxes your actually losing more income then if you paid off the mortgage to begin with (which might I add if you have 200k laying around as per his example you are quite wealthy).
Further issues: Buying a 10 year bond means you need to ride it out until 10 years or risk losing money if for whatever reason you need to sell early because as the interest rates continue to rise you lose a premium because your interest rate is worth less than a new 10 yr bond. Why is this important? Let’s say you have a change in pave in life (upsize, downsize, better paying job across the country etc) you’re going to lose money just to sell before the 10 years. Your 200k will probably be needed for a downpayment on thee next property.
I still can’t believe he didn’t take in taxes
You’re either lazy or ignorant because you did not fully ready the post or understand the theoretical concept of this activity.
Why not fully read the post? Interest income from Treasury securities is subject to federal income tax but exempt from state and local taxes.
Are you a renter? If earning risk free income is the worst advice, then I shudder to think when you really do get bad financial advice.
Doug, I agree that when making such decisions, one should consider the differences in tax implications, between mortgage and T-bond interests. That being said, I think Sam’s reasoning is solid. If I were able to secure a 30-yr fixed mortgage with 2.5% rate(assume I bought in late-2020), now the 10-yr T-bond is at ~2.8%, there is a spread of 0.3% that’s virtually risk-free. Plus, it is more than possible that 10-yr rate will keep rising, especially before the inflation is under control. That only makes this proposition even more attractive. The exact numbers don’t matter, since they change constantly. Qualitatively, Sam’s analysis holds.
I made the false assumption to assume that everybody will naturally figure out their after-tax numbers. So I should spell it out more for the general public. I’ve done just that by adding this passage in the post.
First of all, interest income from Treasury securities is subject to federal income tax but exempt from state and local taxes. Meanwhile, the interest on a mortgage up to $750,000 is deductible. If you live in a high state tax state like California, Connecticut, New York, and New Jersey, buying Treasury bonds is relatively more attractive.
Let’s say you lock in a 30-year fixed mortgage rate at 2.5%. If you pay a 22% marginal federal income tax rate, your effective mortgage rate is 1.95% assuming no AMT and you can deduct all the mortgage interest.
Now let’s say you buy a 10-year Treasury bond yielding 2.8%. If you pay a marginal 22% federal income tax rate on 2.8%, then you will earn a net 2.184%, which is still a 0.234% positive spread%.
Of course, if you can pay a lower tax rate on the Treasury bond yield and or deduct a greater percentage of the mortgage interest, your “living for free” spread will increase. Everybody’s income and tax rates are different, so please run the numbers to calculate your true benefit.
Thanks for all the feedback. Taxes are complicated, but definitely an expense worth including.
Yes, you should include taxes in your final analysis. Everybody’s tax rate is different and Treasury bond income doesn’t face state and local taxes.
Some people have very large mortgages above the maximum mortgage amount for interest deduction. While others have small mortgages and smaller incomes etc.
So my 2.125% mortgage might only be 1.75% net after deduction and the 2.8% treasury bond yield might only be 2.25% net after taxes. But that’s still a positive spread.
I bought $40,000 in series I bonds the day before you published (Me + 3 kids). It just seems like a better place to park cash than my checking account in the current market.
Until interest rates continue to rise, making your bonds worth less if you want (or need to) sell them before the maturity date. Your taking unnecessary risk assuming the Feds won’t raise interest rates
Life is one big risk. Buying I Bonds at current rates is low risk in the grand scheme of things. And you can hold them to maturity for no risk.
People have to think about acid allocation and where they park their wrist free cash. I really hope more people can think more broadly about asset allocation.
How did you manage to do that? The Treasury Department general limits I bond investors to $10,000 per year per person. Of course, if you have a four-person household and bought $10,000 in each name, then you could pull it off. The current yield on I bonds is 7.1%, and that yield will rise to 9.6% next month.
I have a TreasuryDirect account, and I can buy bonds up to the $10,000 limit for all my Minor children annually.
From the main TreasuryDirect page, click “ManageDirect” and find the link titled “Establish a Minor Linked Account”.
Ok. This is blowing my mind. I’m ignorant and would like to cure this present condition. I’ve read this 3 times and lack some fundamental understandings. I grew up poor and I am trying to feel my way out of Plato’s cave as it were. Who can point me to some more resources?
Reading every single article of this site is a great start. It’ll put you leagues ahead of your friends. Good luck!
Hi Hudson – Welcome to Financial Samurai! It’s great you are spending time learning about personal finance. It’s a lifelong endeavor and nobody has a full grasp of everything, including myself, who has been publishing 3X a week since 2009.
You can check out my various categories to the right on my homepage. You can also Google “Subject you are interested in + Financial Samurai” and I most likely have written about it before
Everything just takes time to understand. And taking action and winning and losing is all a part of it.
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Regards,
Sam
How much of the expected interest rate hikes are already baked into the current treasury bill yields? For example if the fed raises rates 50 basis points in May can I expect yields to increase or because that was expected they will be close to flat, all other things being equal?
I would say expectations of Fed Funds up to 2.5%/+ is 80% baked in by end 2023.
Wait. Treasury I-Bond coupons are “free money”? Didn’t some other taxpayer have to work to cover that coupon? Moral hazard here.
No, the federal government issues the currency and will always be able to cover the debt obligation. You are likely confused with state and local governments that do not issue currency and require it either directly from the feds or by you etc. Debt for the federal government is entirely different from you and local governments. And before you retort about inflation, contrary to a widely loved theory, currency issuance does not cause inflation…the lack of real stuff does, such as labor, resources etc. Prior to COVID-19 and WW3 dress rehearsal, the feds had been trying to push inflation up for over a decade. They did in a way by pushing asset prices up, federal debt equals more money in the private system. Federal taxes are useful to create demand for currency and to help people get elected by making things simple to those that elect them.
Locked in a 10 FRM at 2.45. Feeling pretty good.
Around 11,000 invested monthly tax deferred in equities and a fixed rate vehicle at 7% adjusting yearly on a 7 year glide. Fixed rate has almost 200,000 in it. It feels like a a solid win. Especially with our house on 10 year fixed at such a low rate. Home will be paid for in about 30 months.
Progress monthly. If we had extra cash we would probably buy some t bills. However, Our cash is our emergency fund. Everything else is tax sheltered. 30% is in ROTH. No debt other than mortgage (death pledge).
We are happy with consistent yet small steps.
Where are you finding those fixed rate vehicles?
It’s through my job. Not accessible to general public. It’s a unicorn.
Great rate and great progress! Nothing feels better than making progress, no matter how big or small.
My wife and I purchased $20k of I-Bonds in December 2021. I picked up an additional $10k in March, and will likely have her get $10k more by end of April. I don’t mind parking it there for now. Curious what the new composite rate will be in May.
9.62%
That’s what I’ve read, that will be nice!
So great! I’m buying all the I Bonds I can.
Since the rate after May will be at least as high 8.5% which beats 7.12%, does it make sense to wait buying until then?
The composite rate is set every 6 months; buy now and you’ll get the 7.12 rate for 6 months followed by the rate of over 8 after 6 months. Yes, it makes since to buy now because the new rate in 6 months could be lower. Also note, once you buy, the money is locked for one year.
You can also consider gifting I bonds to capture the current 6 month rate. For example, buy gift for your wife and your wife buys for you. You deliver on the following years, so if already bought 10000 max this year, you’ll deliver next year to max purchase. All the time the bonds are earning interest. You could spread your entire $200,000 in I bonds and deliver to each other for 10 years. Buy all in April and earn the variable rate of 7.12% followed in six months by the rate over 8% for six more months.
How does that work? My wife and I have already purchased individually I-Bond early this year. Have we already maximized annual limit? Am I right by reading your message, when the interest increases above 8.5% after May, I could buy another $10,000 and give her and ice versa? That would mean effectively we will have purchased $40000 this year.
You’ll buy them via gift box on treasury direct. If you bought individually 10000 this year, you’ll deliver the gift on a year that no purchase has occurred. The max is 10000 per year whether via gift or bought by individual in own account. With gifting, you can pre buy and deliver yearly to each other. The bonds earn the 6 month rate starting at time of purchase; April though August the bond would earn 7.12 and than the 8 percent for 6 months and so forth. If bought now the bonds will have a lag. If bought in may, there will be no lag. However, future rates may be lower than the rate in May because the economy could go into a recession and at worst the rate would go to zero if inflation is negative unless they add a small fix rate which would be earned for the 30 year lifespan of bond.
Hey Sam,
Generally enjoy your articles, but your recent push on I-Series bonds has me a bit confused. While the interest rate on I-Series bonds is enticing on its face, I know that there are two rates that go into the I-Series bonds: a fixed rate and a semi-annual inflation rate that changes every six months. The current offering has a 0.00% fixed rate, which to me means that all of the interest gained at 7.14% is merely to preserve your investment against expected inflation, right?
And if so, doesn’t that mean that any investment performing under the inflation rate of an I-Series would be losing value to inflation?
If not, please correct me.
I think he views it as a cash alternative, or short or intermediate term bond alternative, not for 30 year money. No investment can guaranty you to beat inflation. Locking in a guaranteed 6-9% nominal return over 1 year is better than anything. The market might go up, it might go down. If I could put as much as you wanted into a 1 year guaranteed 6-9%, I would put a substantial amount of my portfolio there
The current I bonds without a fixed interest rate earn a 0% real return and yes, if you earn less than the current composite rate on an an I bond on an investment, your investment is being overtaken by inflation. However, in what is being proposed by buying bonds yielding less that inflation is relative to the mortgage, almost like an annuity against the mortgage.
Yes. You are free to invest the $10,000 in anything else too. Depends on your balance, cash flow, and risk.
I’m trying to allocate as much of my cash/risk-free portion of my capital to I Bonds, which has a purchase limit. But my cash amount is way over the purchase limit of $10,000 per person.
You can keep your cash in a 0.5%-yielding online savings account too. But I’d rather have more.
Our house is paid off. I guess I’m already living for free, not including property taxes, upkeep, trash removal, utilities..
Us too! I know from a purely financial standpoint some people will say I should have invested the extra cash, BUT the peace of mind and 0 risk of ever loosing my house is the extra return I got outside of a financial return.
Hi Sam –
Can you outline some of the advantages/drawbacks of buying through TreasuryDirect vs a bank or broker?
You can only buy I Bonds from treasury direct.
That’s a cool way to look at it! I need to tally up how much risk-free income I’m earning vs my mortgage. But I know at least part of my living is for free, sweet! I’ve also been wanting to increase my bond exposure for a while as I’ve tipped equity heavy. Looks like it’s time for me to log into my investment accounts now…
Yeah, I’m legging in now and buying some bonds, and will continue to buy more if the 10-year hits 3% and above. My bond allocation is tiny and only consists of the individual muni bonds.
So if interests rates can go way up, it’s going to be nice for passive income purposes. Retirees got to get excited!
Have you considered selling your CA muni bond (assuming still adjusted gain) and buy I Bond instead?
No. There is a $10,000 limit for person for year, and I would just buy that I bonds with my cash flow.
Howdy Sam. I’m living for free. Locked in at 2.5% 30 year in Oct 2020. Paid off second of three rental homes simultaneously. The residential rents (3) cover my principal residence payment and the remaining rental mortgage with a few hundred to spare.
Definitely interested in doing the $10,000 max for an I Bond but as funny as this sounds, I wish these weren’t electronic. Anyways, love your site. Thank you
Jim
Good job Jim! 2.5% is great when the average now is 5% for the 30-year fixed.
I can’t believe I was able to buy in 2019 and lock in a low mortgage rate while properties appreciated in value. If I was still renting, my rent would probably be up at least 20%.
I’m glad the housing market will cool and I can earn a higher guaranteed return. Thanks for the logic and heads up!
I’m looking forward to higher guaranteed returns as well when I re-retire. The timing is good. Here’s to higher guaranteed income!
Hi Sam I always love to read your blog. My question is got nothing to do with bond,And sorry my English is not so good. Anyway I thinking cash out 1 of my rental (is been paid off) and uses with some my savings to purchase a condo in SF cash. Is that a good idea? Your thought. Thank you
If you can find a good deal, it’s always a good idea.
There should be more good deals coming up, so be patient.
But in general, I’m not for taking out money in a property to buy more. I don’t like borrowing money to borrow money. Not at current levels especially.
Ah, so here is where you kind of answered my question on your earlier post on what to do about my ARM which is now in year 7 (reset date in April). Unfortunately, I put $10,000 into the home loan and wish I had held it for another bond.
I agree with this assessment the positive side to increased treasury rates is fixed income investments start to rise and bonds become more appealing especially couple with I bonds. I know I get a lot of flack for supporting bonds but if you work hard for your money the last thing you want to do is lose it.
Bonds are going to get a lot more attention now that they’ve sold off and yields are higher.