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.
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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