Roy decides to buy a personal residence, and he goes to the bank for a $150,000 loan. The bank tells Roy that he can borrow the funds at 4% if his father will guarantee the debt. Roy’s father, Hal, owns a $150,000 CD currently yielding 3.5%. The Federal rate is 3%. Hal agrees to either of the following.
• Roy borrows from the bank with Hal’s guarantee provided to the bank.
• Cash in the CD (with no penalty) and lend Roy the funds at 2% interest.
Hal is in the 33% marginal tax bracket. Roy, whose only source of income is his salary, is in the 15% marginal tax bracket. The interest that Roy pays on the mortgage will be deductible by him. Which option will maximize the family’s after-tax wealth?