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For some people/entities with home/commercial mortgages, for the first time in a while, it is possible to invest in US Treasuries at rates higher than the rate on your mortgage. Now, there are complexities around this, but let me give an example of how this might work. I’m affiliated with a group that owns a building worth $3.5 million, with a first mortgage loan of $470K @ 3.8% AEY [Annual Equivalent Yield] and a second mortgage loan of $270K @ 3.6% AEY. The first mortgage loan has a balloon payment in June 2028, and the second mortgage fully amortizes and pays off in November 2035.
When interest rates were low, our best use of surplus cash was to pay down the first mortgage. But now it would be better to buy the 1.25% Treasury note maturing 5/31/2028, presently yielding around 3.93% BEY [Bond Equivalent Yield – AEY ~4%]. This isn’t a large advantage, but when I thought of writing this article 2 weeks ago, prior to the recent CPI number, the yield gap was considerably more compelling.
Now, we may still get a higher inflation surprise over the next few months, unsettling the bond market. Or hawkish FOMC members may continue to blather that rates have to go a lot higher, raising yields on short- to intermediate-term Treasury Notes. (Knut Wicksell had it right with his simplistic rules [yield curve slope], rather than the FOMC with their complex models and fear of the media.) There may be better opportunities in the near future.
My main point for this short piece is to get people to think more broadly about how to find opportunities with interest rates.
Another idea would be for those with residential mortgage loans to buy participations in an FNMA or FHLMC pool with similar characteristics to your loan. Why prepay your 3% loan when you can buy a participation in loans like yours at a yield of 6%?
I realize that I am glossing over a lot of things here, but this is simply to suggest that your behavior in higher-interest rate environments should be different from that in lower-interest rate environments.
Disclosure: None.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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