Today, we continue the 2 part series: Should I Pay Off My Mortgage Early? Click here to read the first post. This post will look at two common arguments against paying off your mortgage early.
Lose the Home Mortgage Interest Deduction
One is that you won’t be able to take the home mortgage interest deduction and reduce your taxable income. First off, in order to claim this credit, you must itemize your deductions which a majority of Americans do not do; most take the standard deduction.
Let’s say you do itemize and can claim this deduction. We’ll say you’re in the 25% income tax bracket. You have a 30-year, $200,000 mortgage with a 5% interest rate. You would pay your mortgage company $10,000 a year in interest (5% of $200,000 is $10,000).
Now for your big write-off. Since you’re in the 25% tax bracket, you’ll be able to write off 25% of the interest you paid on your mortgage. Using the above-mentioned numbers, your write-off would be $2,500 (25% of $10,000 equals $2,500).
So, if you think you should keep your mortgage because of this deduction, you are basically saying that one should pay $10,000 a year in interest to his/her mortgage company so this person can reduce his/her taxable income by $2,500. I am no mathematical genius, but paying $10,000 to save $2,500 doesn’t make much sense to me. If you find someone who likes this math, please give him/her my contact information and I will gladly write them a check for $2,500 in exchange for $10,000.
Investing the Money is a Better Return
Another argument I’ve heard against paying off a mortgage early is that one could invest this money and earn more in the stock market. That is hard to argue against because it is true. If your mortgage rate is 5% and you pay it off early you will, in essence, be earning 5% a year. The stock market averages over 10% growth a year so, mathematically, paying extra towards your principal instead of investing this amount is not wise.
Here is where we have to take a look at the bigger picture. Since this is the case, why don’t more people take out a home equity loan and invest all of this in mutual funds? One could borrow money at a 5% set interest rate and earn over 10% on this same money by investing it— sounds like a no-brainer to me.
Once again, here is where we need to take a look at the emotional impact of such a decision. Most people will not do this because they don’t view their house as just an investment—it is a huge part of who they are. In fact, according to a 2011 poll conducted by Allstate/The National Journal Heartland Monitor, the best reasons for home ownership are:
- Having a place to raise a family 40%
- Building equity rather than paying rent 26%
- Making a good long-term investment 13%
- Acquiring an asset you can pass along 9%
- Being part of a neighborhood and community 6%
- Following in your parents’ footsteps 2%
- Getting a tax deduction 2%
While you could invest this money, imagine the feeling of owning all of your possessions! I bet the grass in your backyard feels a lot different when you own it.
So, after reading these two posts, are you convinced that you should position yourself to pay off your mortgage early? Please let us know what you think about this in the comments.
About Danny Kofke