Wednesday, July 11, 2007

An Idea for Locking in a good Mortgage Interest Rate

I've been floating this idea around in my head on and off for a while now, and the recent slight dip in treasury yields (which form the basis for mortgage rates) pushed it back up to the front of my mind. It's not perfect, there's a chance it has been done already, and it may not even work in practice, but here goes...

So I want to buy a house. I am going to need (for example) $200,000 in addition to my cash on hand, which I will have to mortgage. Treasury yields have fallen a bit lately, so let's say that even though I dont have a house, I plan to buy one in the next couple of years, and I want to borrow my $200,000 at 6% now because I think rates are going up.

I envision a product sold by a financial institution that would let me borrow the $200k at 6% provided I invest the $200k, plus my $100k down payment, in a portfolio of high-grade bonds, for example AA corporates, until I take it out and use it to purchase a house. As of today, corporate bonds that mature in 2 years yield approximately 5.28%.

The quality of a diversified, highly-rated bond portfolio should be enough security for the bank to offer me the money at mortgage rates, especially given my high credit score. So anyway, I have my $300k locked away in a separate account where the yield on the bonds pays me a taxable $15,840 a year (.0528 x $300,000). The interest on the mortgage is $12,000 a year, which the bank can take comfort in the fact that I have $300k in assets earmarked in a separate account to generate that kind of income. Depending on how regulators and the IRS treat this $12,000, I would argue that it deserves tax-deductible treatment like any other mortgage. The excess between the $12,000 and the $15,840 would add to the account value.

When the time comes to purchase the house, I liquidate the portfolio and pay the cash to the seller.

Of course there's plenty of hair on this dog, but that's the bones of the idea.

I have no idea if this has already been done, or if there's something I'm missing. Just throwing that out there. Feel free to pick it apart, internet dwellers!

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