Mortgage Deduction Not All It’s Cracked Up To Be

One of the things that I hear frequently from people is a reluctance to pay down their mortgage because of the tax deduction they receive for the interest on the mortgage loan. The mortgage interest tax deduction is a huge incentive to buy a home and helps reduce the overall cost of housing relative to a similar rent payment.

However, while the mortgage interest tax deduction reduces your effective interest payment on your mortgage loan, even net of the deduction, you still pay interest under every tax bracket. The benefit of paying down your mortgage and eventually paying it off is that you eliminate your interest payment. Paying nothing is always better than paying something.

When Jeff and I paid off our mortgage, I had a fantasy of a small celebration at the bank where bank employees shook our hands and clapped us on the back. Turns out the event of paying off a mortgage is so rare, our bank employees didn’t know exactly how to do it. So my dreams of fan fare quickly faded as managers were called in and experts phoned to find out the correct procedure to close out a mortgage loan. Ultimately we walked out of the bank a little deflated but with the correct paperwork. We’d have to make our own celebration at home.

In the coming months it was great to not have to make a payment every month. It meant an extra $1,200 a month went into savings, and our nest egg was growing faster. We were no longer getting a tax deduction, but not having to make a house payment  more than compensated us for that loss. It also meant that no matter what, we would have a home.

Paying our mortgage off early also meant we reduced the overall cost of our home relative to keeping the loan for its full term. Suppose you have a $100,000 mortgage with a 4.75% fixed rate 30 year term. Over the life of the loan, you will pay $87,793 in interest. If you are in a 30% tax bracket your net interest costs will still be $61,455. If instead you double your payments, you will pay off the loan twenty years early and pay total interest of $25,989. That’s right, you pay it off in substantially less than half the time! With the tax deduction the net interest paid will be $18,192. That is a savings of $43,262, which is greater than the total tax deductions on the full term loan.

The tax deduction is a benefit for as long as you have to have a loan on your home, but not having a loan is even better. Paying no interest is better than paying less interest after taxes. So pay down your mortgage as much as you can. Even a few dollars a month can add up, and every extra dollar you pay goes directly to reduce the principle on your loan and therefore the interest you pay. Remember, reducing debt is as good as increasing savings. Save early and save often.

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