Should You Keep Your Mortgage for Tax Purposes?

If you study personal finance at all, you will find conflicting accounts of whether or not you should pay off your mortgage. Some say to get out of debt as quickly as possible, and that means pay extra on your mortgage. Others say that since you can deduct mortgage interest from your taxes that you shouldn’t pay off your mortgage as quickly as possible. But how does it actually work out? Your accountant in Billings, MT looks at the numbers and helps you decide what is in your best interest.

How Much Interest Your Pay

The decision to pay your mortgage off early or to keep it around for the tax deduction, all depends on how much interest you actually pay. So we will look at two scenarios in order to determine if it makes more sense to pay off your mortgage early or just let it run its course.

In our first scenario we are buying a new house. Our total mortgaged amount is $200,000 and we got a good deal at 4% interest on a 30 year fixed rate mortgage. For ease of calculations our first payment was on January 1^st of the year. Over the course of 12 months we make payments totaling $11,457 of which $3,522 is principal, and $7,935 is interest (keep in mind every payment more goes toward principal and less toward interest).

If we itemize our deductions, which means we have to come up with $4,465 for a married couple (to put us over the standard deduction), then paying on this mortgage will save us $1,983 off our taxes (assuming a 25% tax rate).

In our second scenario we are an existing homeowner. We have a loan with the same terms, but there is only $100,000 left on the mortgage. Over the course of 12 months we still make payments totaling $11,457, but this time $7,572 goes to principal and $3,885 is interest.

Assuming we still itemize, and have $8,515 of other deductions, then we can save on our taxes with paying our mortgage. But now those savings are only $971.25.

Now here is the situation: in scenario #1 you spend $7,935 to save $1,983. In scenario #2 you spend $3,885 in order to save $971.25. In other words, you spend a dollar to save a quarter. Unless you need that itemization to push you up and over the standard deduction, it doesn’t make a lot of sense to keep your mortgage around for the tax deduction. You can calculate your mortgage and amortization over at Bankrate.com.

Other Factors to Consider Regarding your Mortgage

However, there are several other factors that play into the keep-it or pay-it-off decision.

First of all, can you even afford it? If you don’t have an emergency fund, and you are skimping on your retirement fund, then you are better off keeping the mortgage. Use those extra payments to boost your other accounts before trying to pay off your mortgage early.

Liquid money is always better. Having your net worth tied up in your house is almost never a good idea. If you need cash, you will have to sell the house or take out an expensive home equity loan. Unless you have other resources, you might not want so much money tied up in the house.

Finally, you could likely get a better rate by investing the money. If you have a 4% interest rate, your after-tax savings rate is 3%. Over the long term, your investments should make far more than that. Why give up an 8% return in order to get a 3% return?

There is a lot that goes into the decision to pay off your mortgage. If you are simply keeping it around for the tax benefits, then you are actually losing money (pay $1 to save $.25). But if you are keeping it around because you don’t have other resources, and you have the discipline to invest it elsewhere, then it makes a lot of sense to keep the mortgage around.

Practical Taxes is a full service accounting firm in Billings, Montana. If you have a mortgage and other deductible expenses, we can make sure to get you the biggest refund available. If you are a business owner and need other services like monthly accounting, payroll services, or more, then let us know and we can help you out. Call 406-894-2050 to learn more.