Should I pay off my mortgage?

Posted by  on Oct 10, 2012

Q: I've got about ten years left on my mortgage, with enough savings to pay off the remainder. People tell me I'd be a fool to give up the tax deduction on mortgages. What do you think?

A: People love a tax deduction -- so much so that taking advantage of one often distorts their thinking about whether they are really coming out ahead as a result.

Consider your situation from a few different angles. Suppose you have a 20 percent tax rate. Today's mortgage rates are around 3.5 percent (with an older mortgage, you may be paying a higher rate -- but read on for that discussion.) Thus, a mortgage deduction would come out to roughly 0.7 percent of your principal balance. However, you would be paying 3.5 percent to get that deduction, so you'd still be down 2.8 percent. Clearly, it would be better to pay off the mortgage and do without the deduction.

Another reason people give for not paying off a mortgage is the opportunity to make more money by investing the money than they would save by putting it into the mortgage. However, when you balance savings account rates of 1 percent or less against mortgage rates of 3.5 percent, it's hard to see how that course would put you ahead. Perhaps you could do better in the stock market, but that's far from a sure thing. Remember, too, that you would have to pay taxes on any interest and investment gains you earn.

Perhaps the strongest reason not to pay off your mortgage is to make sure you keep some liquidity for emergencies. You wouldn't want to put your last dime of savings into paying off a mortgage, only to find yourself caught short by some unanticipated expense. However, if you have ample liquidity, paying off a mortgage is a good idea.

At the very least, look into refinancing. Assuming yours is an older mortgage (with only ten years left), chances are your rate is much higher than today's mortgage rates.

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