Usually around tax time each year I get the question about whether or not it makes sense to pay extra on your mortgage to pay it off early. There are two sides to the argument: 1) pay it off as fast as you can so you’re out of debt, and 2) don’t miss out on the opportunity to save on your taxes by deducting mortgage interest. Let’s break each of those thoughts down, shall we?
“Pay it Off” Argument
The folks in this camp don’t like debt. They oftentimes can’t itemize their taxes so having mortgage interest doesn’t help them any and so they want to get rid of the debt. This is the camp in which your grandparents likely fall and those who don’t want to deal with complicated money matters. Their answer is simply, debt is debt and I don’t want to be in debt.
“Take the Tax Deduction” Argument
The folks in this camp are usually more sophisticated, higher income earners and thus have higher tax responsibilities. Many times they learned some things about finance in college and so they realize tax deductions are generally a good thing because it keeps you from paying as much to the government in taxes so they do everything they can to lessen the chance they’ll owe anything come April 15. This may include things like upgrading to more efficient appliances, buying hybrid or electric cars, claiming no dependents (sometimes referred to as “zero single”) on their W-4 so as to be sure not to owe taxes but to instead get a refund.
My Take on It
I say the IRS is a bunch of over-educated, complicated mess of people who do everything possible to squeeze every penny out of income earners they possibly can. That is their job. That being said, I strongly encourage people to get out of every kind of debt. DEBT = RISK, and there is no exception to that equation. If you read my book, you’ll see that phrase in there several times. MIGHT you get a tax deduction for your mortgage interest – yes…sometimes. Does the math work? No. Let me walk you through it.
First off, you can’t get any deduction for mortgage interest if you can’t itemize (and most people can’t itemize based on the small amount of their other deductible expenses). For those who are able to itemize, it is often because of the large amount of mortgage interest being paid, making the real benefit less than if the mortgage was only a small part of the overall deductible expenses. But for the sake of argument, let’s assume you could itemize and get the full tax benefit from having the mortgage. That benefit gained almost never outweighs the cost in interest payments to get the deduction. So, in VERY FEW (almost no) cases does it make sense. Let’s go through an example.
Let’s say you have a mortgage payment of $1,200 per month and the interest portion averages out to about $800 of that (even at today’s rates that’s probably about average depending on where you fall in the amortization schedule). That means over the course of a single year, you’ll pay $9,600 in potentially-tax-deductible interest ($800 x 12 months) on a mortgage. If you have no mortgage, you’d lose that deduction and instead have to pay taxes on the $9,600. If you’re in a 30% tax bracket, you’d owe the IRS $2,880 in taxes (30% of $9,600). So…the math works out that you’d be paying $9,600 to the bank to save $2,880 in taxes. That math doesn’t work! Repeat the example with your own mortgage information and see if you can be the rare example where the math works. I bet you can’t make the math work.
Call me simple, unsophisticated, or even flat stupid if you wish, but I think I’ll stick to living in my paid-for house anytime over taking on a mortgage payment. If there is any debt I will condone it is a mortgage, but pause for a moment and think about how awesome it would be to live a life with no payments! Don’t get stuck in the mindset of society that says you can’t own a car without a car loan or a house without a mortgage. Pay off your mortgage early and live debt free! I promise it is worth it.