For those of you with a mortgage or who are about to get a mortgage, an excerpt from http://www.nber.org/digest/apr07/w12502.html

“Many financial advisers suggest that homeowners…speed up their debt payments, either by paying down their 30-year mortgage early or by taking out shorter-term mortgages. But by examining a large subset of these homeowners, the authors find that nearly 4 in 10 (38 percent) of them would save money by ignoring the advice.”

In their push to reduce their debt, many homeowners are missing a low-risk opportunity to increase their wealth. The reason? They’re making extra payments on their mortgage - or taking out mortgages shorter than 30 years - rather than funneling that extra cash into tax-deferred retirement accounts. In The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings (NBER Working Paper No. 12502), authors Gene Amromin, Jennifer Huang, and Clemens Sialm find that the costs of using this approach can be significant.

Of course, to benefit from such a strategy - what the authors call a “tax arbitrage” - homeowners have to have a mortgage, the option to put more money into a tax-deferred retirement account, and a “get-out-of-debt” mentality. Indeed, many financial advisers suggest that homeowners who are in that position speed up their debt payments, either by paying down their 30-year mortgage early or by taking out shorter-term mortgages. But by examining a large subset of these homeowners, the authors find that nearly 4 in 10 (38 percent) of them would save money by ignoring the advice. Instead, they should redirect those extra mortgage payments into a tax-deferred retirement account (TDA) invested in fixed income securities.

“Depending on the choice of the investment asset in the TDA, the mean gain from such a reallocation ranges between 11 and 17 cents per dollar of misallocated savings,” the authors write. “In the aggregate, correcting this inefficient behavior could save U.S. households as much as 1.5 billion dollars per year.” …

Homeowners may pay a higher interest rate on their mortgage than they can get on a low-risk investment, but the real cost of borrowing is often lower because mortgage interest is tax-deductible. The higher the tax deduction on mortgage interest, the greater the possibility that an alternative investment may earn a better return. The authors look at two alternatives: Treasury bonds (considered super-safe because they’re backed by the federal government) and mortgage-backed securities (which earn a higher return but still are considered low-risk).