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The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings

43 Pages Posted: 18 Mar 2006  

Jennifer C. Huang

University of Texas at Austin - Department of Finance

Gene Amromin

Federal Reserve Bank of Chicago

Clemens Sialm

University of Texas at Austin - McCombs School of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2007

Abstract

Many households face the trade-off between paying an extra dollar off the remaining mortgage on their house and saving that extra dollar in tax-deferred accounts (TDAs) used for retirement. We show that, under certain conditions, it becomes a tax arbitrage to reduce mortgage prepayments and to increase TDA contributions because of the tax-deductibility of mortgage interest and tax-exemption of qualified retirement savings. Using data from the Survey of Consumer Finances, we document that a significant number of households that are accelerating their mortgage payments instead of saving in a TDA forgo a profitable tax arbitrage opportunity. Finally, we show empirically that this inefficient behavior is unlikely to be driven by liquidity or other financial constraints. Rather, the observed behavior can be attributed to a certain extent to the reluctance of many households to participate in financial markets as either lenders or
borrowers.

Keywords: Retirement Savings, Mortgage Financing, Tax Arbitrage, Savings Decisions

Suggested Citation

Huang, Jennifer C. and Amromin, Gene and Sialm, Clemens, The Tradeoff Between Mortgage Prepayments and Tax-Deferred Retirement Savings (March 2007). Available at SSRN: https://ssrn.com/abstract=891546 or http://dx.doi.org/10.2139/ssrn.891546

Jennifer Chunyan Huang (Contact Author)

University of Texas at Austin - Department of Finance ( email )

McCombs School of Business, B6600
Austin, TX 78712
United States
512-232-9375 (Phone)
512-471-5073 (Fax)

Gene Amromin

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
230 S. LaSalle
Chicago, IL 60604
United States
3123225368 (Phone)
3123226011 (Fax)

Clemens Sialm

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

HOME PAGE: http://faculty.mccombs.utexas.edu/Clemens.Sialm/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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