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This might be a dumb question, but I’m wondering if this is resembles a strategy that people take advantage of.

Suppose you currently have a mortgage with an interest rate that’s much lower than the current interest rate. Would it be possible to take your monthly payment, and instead of paying your mortgage with it, buy some zero-coupon bond, and then pay your mortgage with the proceeds of that? The basic idea seems pretty simple.

If so which bonds are the most suitable? I haven’t looked into it too much but I suppose I would be concerned about finding ones that are small enough or that have low enough transaction costs, or low enough default risk.

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    You can't buy a bond instead of paying your mortgage. You might buy a bond now with additional money, then use part of the proceeds when you eventually redeem it to make another mortgage payment and have some left over. But this alone is not sustainable, in the sense that a single bond you can likely afford will never provide enough gain to buy an equivalent bond and make a mortgage payment. (If you can afford it, you probably have enough money to pay off most or all of the mortgage instead of paying it off over time.)
    – chepner
    Jan 30 at 16:58
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    @chepner If you could buy a risk-free bond from the government with a higher rate of return than your mortgage, why would you pay down the mortgage instead of buying the bond? [There are some circumstances where you may decide this, but if the opportunity to do this comes up, it doesn't seem likely that the best choice is to just pay down your mortgage early, instead].
    – Grade 'Eh' Bacon
    Jan 30 at 17:04
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    Yes, if you buy a 4-week T-bill now, you can redeem it in 4 weeks, but you still need to make your mortgage payment in the mean time. Once you redeem the bill, you can make another payment with a small amount left over. Whether that difference is worth the effort is up to you, but you aren't paying your mortgage with the bonds.
    – chepner
    Jan 30 at 17:29
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    It’s a “dumb”question, because you’re asking “what happens if I don’t pay my mortgage?” (which is what “take your monthly payment, and instead of paying your mortgage, buy some…” means. The answer is obvious.
    – RonJohn
    Jan 30 at 22:37
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    @RonJohn please try reading the entire sentence and quoting me correctly.
    – Taylor
    Jan 31 at 0:11

2 Answers 2

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You are unlikely to be able to avoid paying down your regular mortgage payments (which will need to be made based on the required payment schedule). Instead, consider this in the context of what additional investing decisions you may make. Many people decide to only pay their required mortgage amounts every month, and if they have the financial means to do so, will decide to invest in the stock market [through their work pension plan or otherwise] instead of further reducing their debt.

The downside to doing this is that if you invest in assets with risk, then your overall return may be lower than if you had just made extra payments against your mortgage balance to reduce your ongoing interest. And you are unlikely to find a risk-free investment with a better return than your mortgage rate. So some people may prefer to pay off their mortgage early, rather than heavily invest [common advice is to always at least get your employer's pension match, if any, if you have the financial means to do so].

In most circumstances, your personal mortgage interest rate is likely the best 'risk free investment rate' that you can possibly earn. Conceptually, the reason your mortgage rate is typically higher than risk-free government borrowing, is that you as a borrower are a bigger risk to your bank than the government is, all else being equal.

Over time, the interest rate environment may change, and if your mortgage rate is fixed, then rising interest rates may cause government bonds to have higher payout rates than your mortgage rate. If your mortgage interest rate is lower than what you can earn through investing, then this means that at a bare minimum, you could likely benefit by making only the required payments, and using any surplus cash for investing in higher-rate fixed term investments. The opportunity to invest in higher-risk equities still exists, but with the same caveats as always.

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  • If you do decide to take advantage of a low fixed rate by investing elsewhere, consider what will happen when your fixed rate expires and you are forced to take a new loan at a higher rate. You are likely to want to be able to access that money to reduce the amount of your new mortgage, so make sure it's not locked in a long term investment.
    – thelem
    Jan 30 at 18:04
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    @thelem Yes - in for example Canada, you can't fix your mortgage rate for more than 5 years, so you likely wouldn't want to buy any 5 year bonds - even in the US if you had 20 years left on your mortgage with a fixed rate, buying a fixed rate bond with a 20 year term could create risk if you decide to move in 4 years. So individual considerations must also be made
    – Grade 'Eh' Bacon
    Jan 30 at 18:29
  • In most circumstances, your personal mortgage interest rate is likely the best 'risk free investment rate' that you can possibly earn. is less true currently than it usually is because of rising interest rates. If you fixed your mortgage rates for a decent period, you could well be able to earn more even on simple risk-free savings (I did for about 6 months late last year)
    – Chris H
    Jan 31 at 9:59
  • @ChrisH Even in the current interest rate environment, the reason someone may have a mortgage rate lower than the risk-free rate is that their mortgage rate was locked in before interest rates increased.
    – Grade 'Eh' Bacon
    Jan 31 at 14:09
  • @Grade'Eh'Bacon yes, as I said: If you fixed your mortgage rates
    – Chris H
    Jan 31 at 14:11
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It somewhat resembles a strategy that many people used. Note that the first major obstacle in this type of scheme is taxes. If you can invest at 5%, and pay tax on gains at 20%, then your loan must be below 4% to profit from it. And if the tax is 40%, the loan must be below 3%. This will almost certainly break any simple scheme.

However, in the UK in the 80's there were products called endowment mortgages. These packaged an interest-only loan with an endowment (a life-insurance product that you pay into regularly and then pays out after a fixed time such as 15 years). Due to tax regulations, these were potentially profitable (tax relief for interest on mortgage loans and favourable tax treatment for life insurance products). People found that when the endowment matured, it had earned significantly more than needed to pay off the loan, so they had a good profit. This became very popular. Over years, the tax treatment became less favourable on both parts, making them less reliable. The economic environment also changed until people started finding at maturity of the endowment that they were left with less than needed to pay the outstanding loan amount. This got so bad that people then started legal action claiming that they had been mis-sold an endowment mortgage under the impression that it was a great way to make money. Lots of compensation was paid and I don't think any institution would now sell such a product nor would anyone buy it.

There are two lessons from this: taxation is vitally important to success, and you need provision for when things go wrong (i.e. take account of the volatility and liquidity of the investment and whether trading can be suspended for any reason).

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  • I think "claiming that they had been mis-sold an endowment mortgage under the impression that it was a great way to make money" is being a little unfair. When I got my first mortgage in the mid-90s, the Natwest advisor tried really hard to sell me an endowment, and the interest rates he was using on the illustrations were eye-watering. I'd not heard of any mis-selling at that point, but I still went for the traditional repayment. He even got me to sign a letter saying that I'd ignored his advice! The reason these were mis-sold was the huge back-handers the people selling them received.
    – SiHa
    Feb 1 at 6:54

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