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> If inflation hits 4% and your mortgage is 3.5% you would be making 0.5% a year off the mortgage interest

This ignores the rates-price and inflation-rates nexuses. When inflation goes up, ceteris paribus, rates rise. When rates rise, all else held equal, the price of leveraged assets like real estate falls.

TL; DR this trade is an arbitrage only if you've perfectly hedged the price of your underlying asset, the house.

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Agreed this is an overly simplified model. Another thing to keep in mind would be population dynamics. Are people moving out of the area the home is in (Chicago) or are people moving in (Nashville).

The hedge is refinancing out any market appreciation, like a piggy bank, keeping debt high while interest rates are low, you can always hand back the key if it goes south.

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