Say you have a $200,000 mortgage at 3.5%. Your annual mortgage interest cost would be $7,000. That $7,000 can then be used to reduce your taxable income, saving you $7,000 of taxable income! If, like most people, you are in the 25% federal tax bracket, you pay $1,750 less in income taxes now because of that. So the net $7,000 minus $1,750 makes the true net after-tax cost for the mortgage only $5,250. That $5,250 is your 2.625% net-effective after-tax rate to borrow money.