NCPA - National Center for Policy Analysis


May 8, 2007

In their push to reduce their debt, many homeowners are missing a low-risk opportunity to increase their wealth by 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, according to Gene Amromin, Jennifer Huang and Clemens Sialm, in a National Bureau of Economic Research Working Paper.

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. Examining a large subset of these homeowners, the authors find:

  • Nearly 4 in 10 (38 percent) would save money redirecting extra mortgage payments into a tax-deferred retirement account invested in fixed income securities.
  • Depending on the choice of the investment asset, the mean gain from such a reallocation ranges between 11 and 17 cents per dollar of misallocated savings.
  • In the aggregate, correcting this inefficient behavior could save U.S. households as much as 1.5 billion dollars per year.

Why more households don't take advantage of the tax arbitrage remains something of a mystery.  True, Americans often make costly financial mistakes.  The paper cites other studies showing households putting money into taxable accounts when they'd be better off using tax-free instruments.  But the breadth of the mismatch in this case can't be explained entirely by a set of rational decisions, the authors write.  Instead, many homeowners may be so averse to debt that they prefer to pay down their mortgages early rather than to maximize their overall wealth.

Source: Laurent Belsie, "Retirement Saving Versus Mortgage Paydowns," NBER Digest, April 2007; based upon: Gene Amromin, Jennifer Huang and Clemens Sialm, "The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings," NBER Working Paper 12502, August 2006.

For text:

For full report:


Browse more articles on Economic Issues