Does It Make Sense to Not Pay Off a Mortgage Due to Tax Deductions?

Extra payments each month can significantly speed up your mortgage repayment.

Extra payments each month can significantly speed up your mortgage repayment.

Choosing not to pay off your mortgage due to tax deductions makes little sense on its own merits, but when you consider other options to invest your money, it might make more sense. Some people can more money investing than they save in mortgage costs by paying off early.

Mortgage Basics

A mortgage is a home loan. You receive funds to buy a property in exchange for agreeing through a contract to repay the loan plus interest. Typical monthly mortgage payments include amounts for principal, interest, insurance and taxes. On a common fixed loan, during early stages of your repayment, much more goes to interest than principal. Over the life of the loan, you usually pay significantly more in interest fees than you pay on the original loan.

Tax Breaks

Mortgage interest is one of the more common and important tax deductions for homeowners. For some, the interest deduction, combined with property tax deductions, makes itemizing more appropriate than taking a standard deduction at tax time. The effect of taking mortgage interest deductions is a reduction in your effective interest rate. Assume you pay 5 percent interest on your loan and claim a mortgage interest deduction of $10,000. This deduction lowers your taxable income by $10,000, which likely saves you a few thousand dollars, depending on your tax bracket. When you subtract the tax savings from what you paid in interest, your real interest rate falls anywhere from a fraction of a percent up to 1 to 2 percent.

Stand Alone Decision

When you consider only your mortgage and the related tax effects of paying interest, it does not make sense to avoid making extra payments and paying off early. Even though you lose the tax deduction, you save much more in monthly interest payments. In essence, you save the difference between your interest payments and the tax deduction on the interest. Plus, if your lost mortgage interest takes your itemized deductions below the standard deduction level, the impact is lessened when you select the standard amount.

Broader Perspective

A better financial consideration is whether not paying down your mortgage allows you to earn more money on other investments. As an investment decision, the net savings you experience on interest when you pay your mortgage early is your return on investment. Assume a moderate net interest savings of 3 to 4 percent by paying off early. This is much better return than a basic savings account. However, bonds, stocks, real estate and business ventures offer higher yield potential. If you can tolerate the potential for loss on these opportunities, you often get much better return than you would putting your extra money into paying off your mortgage.

About the Author

Neil Kokemuller has been an active business, finance and education writer and content media website developer since 2007. He has been a college marketing professor since 2004. Kokemuller has additional professional experience in marketing, retail and small business. He holds a Master of Business Administration from Iowa State University.

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