Is the benefit of paying off your house worth losing the income tax deduction? What are the overall benefits of paying off your house?
Thanks.
Instead of paying $x/mo to the mortgage, you now keep $x/mo in your pocket. Or your savings account.
And if you lose your income, you do not need to come up with $x/mo out of thin air.
My income tax deduction is worth like 1, maybe 1.5 payments per year and of course it goes down every year. In 10 years it will be a paltry amount.
You’ll get lots of opinions on this.
Most will say that it depends if you think the money that you use to pay off your loan could make you more money in the market. But you have to make more money and pay the taxes on that.
I think the tax break is a big red herring. I’ll take the $1.00 payment on interest and give you $0.25 back in the form of a tax break. I’ll do this all day with you until to figure out it’s a bad deal.
Lastly, I feel great that I don’t have a mortgage payment. Really great. I can get by quite a while with my savings and nothing coming in with no mortgage payment.
You will never save more in taxes than you pay in interest (except possibly in a very few edge cases). So the advantage of paying off your mortgage is lower interest. There is also a risk-adjusted return to consider. The mortgage interest you pay may be very low when you consider the tax benefits but paying off the mortgage can be viewed as a perfect risk-free rate of return equal to the after-tax rate of interest. Super short-term T-bills are considered “risk free” in investing even though they really have some risk, including default risk when Congress gets antsy about upping the debt ceiling.
The shortest term T-bills are paying 0.2% annually right now and that is taxable. Unless your after-tax mortgage rate is less than that, paying your mortgage is a safer investment. 30-year mortgage rates are about 3.5% right now and very few people pay more than 50% marginal tax rates including federal state and local taxes, so they have an after-tax mortgage rate of 1.75%. So, paying off your mortgage is safer and better than investing in T-bills.
The benefit is that you no longer have to pay interest on the loan.
The income tax deduction for home mortgage interest means that you can reduce your taxable income by the amount of the interest. So if you are taxed at a marginal rate of 25% (made up number) and your interest for a year is $4000, you can reduce your taxes by 0.25 x 4000 = $1000. So you still pay $3000 in interest after taxes.
If you have an investment that will pay you more than the interest you have after taxes for your mortgage then it makes sense not to pay off your mortgage. If you don’t have that investment than it makes sense to pay off the mortgage.
Let’s get this out of the way first:
You do not save money by taking an income tax deduction.
You are deducting the interest that you paid on your loan. If you don’t have a loan, you are not paying that interest.
The primary benefits of paying off your house are:
[ol]
[li]You are no longer paying interest on a loan[/li][li]There is no threat of foreclosure should you lose your source of income (except maybe if you don’t pay your property taxes for a while)[/li][li]You can direct a larger portion of your income to other priorities, such as retirement accounts, savings, or hookers&blow.[/li][/ol]
The disadvantages are
[ol]
[li]You have a lot of money now tied up in a very illiquid asset (your house.) This can be difficult to access if there is an emergency, and you may have to do so under unfavorable circumstances (say interest rates go up, and you suddenly need to borrow against your paid-off house.)[/li][li]The money you spend now paying off your (presumably) very low-interest mortgage could earn a higher return if you invest it instead. [/li][li]A lengthy history of on-time mortgage payments excellent for your credit score. A payoff is good, too, but long histories are better.[/li][/ol]
And such investments are very, very rare. If they were common, then the bank would be buying them, instead of giving you a loan at that rate.
Part of what is so awesome about paying off your mortgage has to be that you pay it for soo long! (AND rent before that!) Months and months. Years and years. The better part of your adult working life, for most people! When the day finally arrives, how can it not feel wonderful just to have it come to an end.
Just be sure to do your “worst case scenario” calculation before you pay off your mortgage. Decide how much cash you need to have readily available to weather you think is a realistic “worst case”, and don’t use that money when you figure out how much you have to use towards paying off your mortgage. Most financial advisers say something like “3-6 months of normal expenses in reserve”.
And keep in mind that it’s not a binary decision. It still might make financial sense to pay your mortgage off more quickly than planned-- that is, pay off more principal than your normal mortgage calls for. You just have to do the math and see which strategy nets you more money afterwards.
One thing that I don’t think has been mentioned is that if you have not yet paid off the mortgage and your house value plummets for whatever reason, you at least have some options in getting out of the mortgage if you find yourself deep underwater. If you’ve paid it off already then obviously 100% of the loss is on you.
Also, for a long term mortgage, consider the possible effects of inflation. If we see a lot of inflation over the few couple decades, you benefit somewhat since those future dollars you pay will be worth less than today’s dollars.
Hard to say how likely these would come into play but still worth mentioning.
When the stock market is going up and up it feels like you could do so much better with a big mortgage and your money invested in the market. But when there is a crash like in 2007-2008 these feelings rapidly reverse.
But for most of us who own their home free and clear, the reasoning is more psychological–I own my house instead of the bank owning my house. And a lot of us are hostile to debt of any kind (my only debt is credit card which I pay off in full every month–which I only do for rewards).
There’s no deduction to lose. In 25 years of home ownership, I have never had enough deductible expenses to beat the standard deduction. In other words, if I deducted my interest I would pay more in tax. Unless I’ve been misinformed, the majority of taxpayers are in the same boat.
There’s also the feeling of pride that you get when the house is finally all yours.
It’s all about risk, though. My guess is that properly underwritten mortgage loans are less risky than investing in something like international emerging markets or other equities. It’s about the return/risk equation, and that’s why banks give home loans. My current interest rate is something like 2.75% and over the life of the mortgage my investments are beating that.
First off, the only way it makes sense not to pay it off is if the money you use to pay it earns a higher return after taxes than your mortgage interest. You probably cannot do that, but if you can go ahead and make the investment instead. If it were that easy, the bank would do it instead of lending you the money.
I am now facing the question, after selling my house, whether to rent an apartment or buy a condo. The tax advantage of the condo is manifest: I am, in effect, paying my rent with untaxed money, while when I rent it is with after tax income. On the other hand, condos subject you to the whims of a condo board. Tough choice.
As others have hinted at, the tax deduction isn’t worth much at all. Let’s say you have a mortgage of $200,000 and you have $200,000 in an account somewhere making interest. If your mortgage is at 5%, then you will pay about $10,000 in mortgage interest this year, and if you can deduct all that from your income, you effectively would save about $3000 in taxes due to the interest deduction. Great, right?
Not so fast - that money you have in an interest-bearing account is making you interest income, which is taxable. If the interest rate on your savings is the same as your mortgage interest rate, those exactly balance each other out. The mortgage interest deduction didn’t save you anything. Of course, you can’t get 5% interest in a savings account right now, but let’s say you have it in an index fund - 5% is pretty reasonable. Looked at this way, the mortgage interest deduction isn’t a government incentive towards home ownership, it’s just something that takes away the disincentive to have a mortgage.
And then the other, bigger factor for most people is the standard deduction, which is over $12,000 per year for a married couple. If you have $10,000 in mortgage interest that you paid, and you gave $3000 to charity, you get to deduct $13,000 from your income. But you’d get to deduct over $12,000 if you don’t have itemized deductions, so the mortgage interest deduction hardly benefited you at all. By paying it off, you do, however, get to avoid income tax on the interest you make on the money you were making from the bank.
So don’t even consider the mortgage interest deduction to have value. Decide whether to pay it off based on other factors - liquidity mainly.
I paid mine off over ten years ago. Of course I just kept paying monthly until it was completely paid off - no need to put up anything but the monthly payment.
So now I can put that money into savings and retirement. And I couldn’t deduct the interest since the early 80s, anyway.
Wow. You guys must live in a different world than I do. If you’re married and filing jointly, the deduction is $13,850. At 4% interest, that’s a loan of $346,250. That’s not a whole lotta house when the median home price is $189,000. That’s only 83% more. This is if you don’t have any other deductions like student loan interest, tuition payments, margin interest on investment accounts, medical costs, HSA/HRA/FSA writeoffs, charitable donations, and the like.
Anyone not have student loan interest? Anyone?
You can get the student loan interest deduction without itemizing, while still getting the full standard deduction. IIRC some of those other deductions (HSA contributions and some tuition payments?) are also allowed without itemizing.