The Tradeoff between Mortgage

Prepayments and Tax-Deferred

Retirement Savings

Abstract

We show that a significant number of households can perform a Tax Arbitrage by cutting back on their additional Mortgage Payments and increasing their contributions to Tax-Deferred Accounts (TDA).

Using data from the Survey of Consumer Finances, we show that about 38% of U.S. households that are accelerating their Mortgage Payments instead of saving in Tax-Deferred Accounts are making the wrong choice.

For these households, reallocating their savings can yield a mean benefit of 11 to 17 cents per dollar, depending on the choice of investment assets in the TDA.

In the aggregate, these mis-allocated savings are costing U.S. house-holds as much as 1.5 billion dollars per year. Finally, we show empirically that this inefficient behavior is unlikely to be driven by liquidity considerations and that self-reported debt aversion and risk aversion variables explain to some extent the preference for paying off Debt obligations early and hence the propensity to forgo our proposed Tax Arbitrage.

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