Does this sound familiar?
You are standing around a family get-together chatting with your Uncle Steve.
You casually mention that you are planning to pay off your mortgage early but Uncle Steve quickly replies, “No, don’t do that. You’ll lose the interest tax deduction which will push you to a higher tax bracket. The only reason I don’t pay off my mortgage is to get this deduction.”
Uncle Steve’s statement rings true so you decide to pay off your mortgage slow and steady like everyone else.
But there is a problem. Uncle Steve is 98% wrong with a small sliver of truth.
Let’s talk through it.
90% of People get NO BENEFIT
The vast majority of people (with the current tax laws) don’t get any benefit from their mortgage interest on their taxes. That’s right, 0 benefit.
The reason is because the only way to get some benefit is to itemize deductions.
Itemizing deductions means that you more have tax-deductible expenses (things like mortgage interest, charitable contributions, etc.) than the standard deduction.
And in 2022, the standard deduction for a married couple is $25,900.
For example, let’s say you and your spouse paid $15,000 this year in mortgage interest and you also gave $10,000 to charity. Added together that is a total of $25,000 of deductible expenses. However, because that is still less than the standard deduction of $25,900 you get 0 extra benefit for those expenses.
Or in other words, you would have gotten a tax deduction of $25,900 even if you had no mortgage interest and hadn’t given a dime to charity.
The other 10% get ALMOST NO BENEFIT
But what about for those that actually do itemize their deductions? Is it worth it for them to have mortgage interest?
The most important thing to understand about this is that a tax deduction does not decrease your tax bill directly. It decreases your taxable income which then decreases your taxes.
For example, let’s say you had a taxable income of 100k and would owe 15k in taxes. However, you have 10k of mortgage interest and you were able to deduct all of it.
This means that your taxable income is now 90k and your tax bill decreased to about $12,800.
This means that you saved $2,200 in taxes!!
But, wait??
We paid $10,000 in mortgage interest to save only $2,200 in taxes.
This means we paid a dollar to the mortgage company in order to save less than a quarter with Uncle Sam. This is a bad trade!!
Other Factors
I am not saying that there is never a reason to keep your mortgage even when you could pay it off.
There are potentially lot’s of reasons to do this.
However, doing it solely for the the “tax deduction” is often a bad reason.
Don’t Believe the Water Cooler Talk
I have seen way too many bad financial decisions made because of the advice of a well meaning coworker or family member.
Not all advice given in passing is bad but we have to remember to double check our sources before we bet our financial future on it.
