My mother-in-law, my wife Nicole and I were standing in our kitchen the other day catching up on life. In conversation, Nicole brought up the fact that we're one year away from paying off our mortgage and we're excited to see what our life is like when we're completely debt-free. Our plans for annual vacations with the kids, starting a business and saving more for retirement all came up.
My mother-in-law was very interested in our decision and asked:
“Don't you need to keep your mortgage for the tax benefits?”
Most everyone who owns a home gets a mortgage interest tax deduction and those are pretty nice come tax time so I completely understood where she was coming from with the question.
I answered her question by saying:
The amount of money we will be saving not paying interest to the bank every year once the mortgage is gone will be more than the tax savings we'd receive from the IRS if we kept our mortgage.
The answer made sense to her, but after she left it got me thinking …
It has been at least 5 years since I've actually looked at these numbers and how the math breaks down.
Bye Bye Mortgage
I took a look at 2015 because it was our last full year of mortgage payments. I wanted to compare it to a full year of making no mortgage payments to make sure I was correct in my statement that the benefits of having no mortgage outweigh the tax benefits of having a mortgage.
|2015: With Mortgage|
|Tax Savings from Mortgage Interest Deduction||$859.04|
|Total Out of Pocket Cost||($2,208.96)|
|2018: No Mortgage|
|Tax Savings from Mortgage Interest Deduction||$0|
|Total Out of Pocket Cost||$0|
From the chart above you can see that even with the mortgage interest deduction we received in 2015, we're still paying over $2,000 per year out-of-pocket.
Comparing this to 2018 when our mortgage is completely paid off, we'll be paying $0 out-of-pocket.
In 2015, we were also making principal payments of around $12,300 annually. When you add in the $3,068 of interest, we're planning on having an extra $15,368 available each year!
Based on all of that information we've decided it makes more financial sense for us to pay off our mortgage. Right now, we're one year away from making it a reality.
Now everyone's numbers are different. Your interest rate could be higher and your tax rate could be different. But no matter how you slice it, paying off your mortgage will save you more money than keeping your mortgage.
I'd love to hear some commentary on this one since this is an often debated subject. I'm not a tax expert and I'm not a certified financial planner. Just a guy with a calculator.
What do you think? Pay off the mortgage? Or keep the tax benefits?
I think you are missing a key piece by looking at just tax savings. I have a mortgage at 3.25%. Locked in, for 30 years. There is no way I’m going to put more than the minimum towards it, and not just for the tax savings (which are definitely a factor) but also because there is very little chance the stock market doesn’t outperform a 3.25% return. Paying off my mortgage early is dollars that could have been invested in the stock market, and it’s literally losing money by paying off my mortgage early. Layer on the tax savings and I think it makes no sense at all, from a math perspective, to pay off your mortgage early.
But most people approach finances from a psychological and not a math perspective.
Not attacking your approach in this comment because I can respect the psychological impact of having no mortgage, but if you remove emotion and psychology I don’t think you can mathematically argue that paying off low-interest debt makes more sense than shoving the extra $ into the stock market.
Excellent comment David! You are correct that a lot of my inspiration in paying off our mortgage is emotional. I’m going to feel a sense of true freedom when I have no payments owed to anyone. It will be very liberating.
My main goal with the article was to point out that the tax savings ALONE is not worth keeping a mortgage.
From the math perspective, my 3% mortgage interest is a guaranteed amount of money that I will be keeping. The stock market is not a guarantee. For example, in 2008 we had an S&P 500 average return of -36% or 2015 yielding only a little over 1%. The point is that I have no idea what the stock market is going to do year over year… no one does. What I do know is that I’m guaranteed a 3% savings by paying my mortgage off early.
Now have there been majorly positive years in the stock market recently? Oh yeah! And I’m taking advantage of those too by contributing about 15-20% of my income in the stock market. I invest in both my workplace 401k and Roth IRA in low cost mutual funds.
Between the freedom of not owing anyone money, having a guaranteed savings of 3% and investing 15-20% of my income in the market, our plan to pay off our mortgage early works for us.
I truly appreciate the comment David. It is notes like yours that will help me continue to grow and become a more savvy money guy. It is a continuous journey of learning for me.