Why We’re Paying Off Our Mortgage Early
To pay off the mortgage early, or not to pay off — that seems to be the question on many personal finance blogs. The arguments against paying off the mortgage early go like this: you’ll lose the tax deduction, and you’ll be better off by continuing to make minimum payments (or even by continually refinancing) and investing the additional money elsewhere.
First, I’ll tell you the reason we’re paying off our mortgage early. It’s mostly emotional. I want to have a place to live that’s paid for. I don’t want to owe any money to anyone, anywhere, ever again. I want to be able to pick up and travel the world on a whim, because my bills are so low. I don’t want to be worried about owing money.
But for those of you who are less emotional, let’s take a look at some facts.
Yes, if you get a tax deduction because of your mortgage, you’ll lose that if you prepay it. But what’s the real value of a tax deduction? Of course, every situation is different, but let’s look at an example using real numbers from the U.S. 2009 tax table.
Suppose you’re married filing jointly. If your taxable income prior to any mortgage interest deduction was $98,950, you’d have owed $17,119 in taxes. If the amount of mortgage interest you paid increased your tax deduction by $10,000 more than the standard deduction of $11,400, and left you with a taxable income of $88,950, your tax would be $14,619. That means that you’d have paid $2,500 less in taxes, but you’d have spent $10,000 just in mortgage interest in order to do so. (Plus you’d have spent an amount to pay down principal; unless you have an interest-only mortgage.) I think I’d rather pay $10,000 less in interest than $2,500 less in taxes.
But in our case, that point is moot. I think we’ve only ever been able to itemize once on our federal return, so none of the interest we pay on our mortgage is actually tax deductible at all. So that argument is irrelevant in our situation, but it may not be in yours.
But what about the investing side of things? Well, suppose we invested the $1000 or so extra per month we’re paying toward our mortgage instead of sending it toward principal, and we did that for 20 years while we keep refinancing our house or moving up in house so that we never pay it off. At an 8% rate of return, according to this investment calculator at the end of 20 years we’d have $568,999 before taxes and inflation. More than half a million dollars sounds pretty darn good to me.
But suppose we go ahead and pay off our mortgage in 5 years, and then send $2000 per month toward investments. In that case, we’d only have $675,213 before taxes and inflation. (Clearly showing the value of investing early and often.) It does sound like it would be a better deal to invest $1000 monthly starting now instead of paying off our mortgage early.
Except that there’s something missing from that equation, because we’d also have a paid-for house that’s likely to be worth $225,000 or more in 20 years. So by prepaying our mortgage within the next 5 years and investing regularly we’d have investments (if we include our house) of $900,213 after 20 years.
So there you have it, some emotion plus 900,213 other reasons why we’re paying off our mortgage early.
The other big reason though is risk. While there are other choices (such as paying off a mortgage on schedule and never moving or refinancing) that could cause things to come out differently, the truth is that I just don’t know how things will go. I don’t know if I’ll be able to get an average annual return of 8%, on anything. I don’t know what life will bring, period. But I do know that if I pay off my house and have good insurance, that barring an act of God or war, I’ll have somewhere to live.
You might be choosing to do things differently, but be sure you’re making an informed choice that takes your own individual circumstances into account.