Cost benefit analysis - taxes

[nfceagles]

Ignoring unusual complications, the amount saved on taxes should always be some fraction of the interest savings. So interest savings should definitely be higher than tax savings. Example, if you pay 1,000 per month on interest and your marginal tax rate is 30%, then you pay 12,000 in interest for the year and you save .30 * 12,000 in taxes. The tax savings isn’t going to be more than the interest itself. Possible complications, like not itemizing, hitting the alternate minimum tax, hitting limits on deductibility are only going to reduce the tax savings but not change the interest cost. The tax deduction reduces the sting of paying interest each month but it should never more than offset it.

That said, there are other valid reasons to hold off paying down a mortgage. The money you take out of savings to pay off the mortgage is now no longer earning interest or investment gains. If you have a low interest rate mortgage, it’s possible the lump sum you take out of savings for paying off the mortgage, could have earned more than the interest you saved. Say your mortgage rate is 3%. By taking 300,000 out of savings and paying off the mortgage, you will save approximately 9,000 in interest next year but lose a tax benefit of .30 * 9,000 so your net savings is $6,300. If that same 300,000 was left in the stock market for the year and the market rose 10% then you would have gained 30,000 but then had to pay taxes of .3 * 30,000 on that gain for a net gain of 21,000. But of course the rate of return on the stock market is not guaranteed. So this consideration really comes down to where the money would otherwise sit if you didn’t pay off your mortgage and your risk tolerance, ie the peace of mind PPs have referred to.


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[nfceagles]

One other reason to not pay off a mortgage, liquidity. If you have 300,000 in savings and a 300,000 mortgage and you lose your job, you can use the 300,000 in savings to pay your mortgage payment as well as feed and clothe and provide for your family for quite a while. If you pay off your mortgage and lose your job, you don’t have a mortgage payment but you also don’t have that savings to pay for property taxes, food, and clothing, etc... Theoretically you should be able to get a home equity line of credit or remortgage the house, but I’m not sure how easy that is to do if you are out of work.

Not trying to sway you, in fact we paid off our mortgage last year. But these are the things I wrestled with along the way.


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[sariana]

You also need to consider what else you could do with that money. If you pay, say, 5% in interest but could invest that money for an expected return of about 8%, you are better off keeping that mortgage and investing.

My husband made a spreadsheet to calculate this very thing (including your question about interest deductions), but I wouldn't know how to do it. We are trying to refinance, and it turns out that for our circumstances the lowest interest rate available is NOT our best option, as long a we invest the difference in the monthly payment.

It is different for every situation: how much time is left on your mortgage, your rate, your tax bracket, etc.

[Zansu]

Ask your accountant for the analysis.

[pinkmomagain]

honestly we paid our old mortgage off and it was amazing. I think you can just go to your last tax return and see the deduction you are getting and then compare that to what you paid in interest last year. But do NOT discount the peace of mind aspect which I believe and many agree is a reasonable plan. Another example is that while you might be BETTER off with a more aggressive portfolio if it causes you stress be more conservative as the squeeze isn't worth the juice.

I agree with this. Owning your house -- free and clear -- is an amazing feeling.

[jgenie]

Thanks so much for sharing your knowledge. You’ve given me lots to think about. Yes, we had paid off our previous home and I loved knowing it was ours. We had originally planned to carry our mortgage here for 10 years but I keep returning to wanting to pay it off now rather than waiting. I’ll have to check in with DH to see if he feels strongly one way or the other.

[belovedgandp]

Lots of great advice. Honestly, it sounds like you're in a great financial position and can't make a bad decision. I don't think there's a correct answer it does depend on where/how you chose to invest and your comfort for risk.

We too had paid off our previous home and it was quite liberating. We stayed there for two years with it paid for and then moved two years ago. Just refinanced this house 20 months after moving because the interest rate drop was enough to justify. My gut is to pay it off, but DH is more comfortable slowing it down and spreading us out. Our oldest is a junior and life is getting more expensive again and while we have college funds the unknown of college just starting for our three on the horizon has us staying the course with such a low interest mortgage for now.