Which is more beneficial?
With the country in the economic state that it’s in and the attention that’s been focused on the mortgage industry, many people are re-examining their mortgages. Some are refinancing to lower their interest rate and others are making additional payments in an effort to pay off their mortgage sooner. Still others are hanging on to their mortgages, even when they have the ability to pay them off, in order to keep the mortgage interest deduction on their taxes. But is that really beneficial?
Ask the Important Questions
When deciding between keeping your mortgage (and the interest deduction) or paying it off, there are many factors to consider. Everyone’s financial situation is different so there is no one best answer. There are important questions to ask when deciding.
- What is my income level? If you have a lower income and it doesn’t benefit you to itemize your deductions, then you can’t claim the mortgage interest as a deduction anyway. It may be more beneficial for you to pay off that mortgage and put the extra cash in an interest-bearing savings account each month.
- Will making extra payments toward the mortgage strap me financially? If your budget is already tight, taking extra funds and putting them toward your mortgage in an effort to pay it off may be more than you can handle. Reducing your tax liability by claiming the mortgage interest deduction may be the better idea for you until your income increases.
- Will my income level change soon? If you’ll be retiring soon and having a lower level of income, it may be harder for you to get a loan later if you need it. In this instance, it may be more beneficial to keep the mortgage and maybe take a home equity line of credit for future use in case of emergencies (as long as you resist the temptation to tap that line of credit now).
- Do I have enough savings and emergency funds? If so, you need to look at the interest rate on your mortgage. If it’s low enough it may not be a huge benefit to pay off that mortgage. Your tax savings may outweigh the benefit of having additional cash in your pocket. You may need the write-off to help reduce your tax liability.
How Much is the Mortgage Interest Deduction Worth?
Generally speaking, for each dollar of interest you pay you get back around 25 cents in a refund. So if you’re keeping your mortgage solely for the deduction you really need to look closely at how beneficial it is to you. Essentially, you’re losing 75 cents on each dollar. Not a great investment if you can manage to pay off that loan.
Use an online calculator at the beginning of the year to determine what your tax liability will be with your current income and deductions. Then calculate it without the mortgage deduction. If there’s not a significant difference you’ll be better off paying that mortgage down and saving yourself a lot of money in interest over the length of the loan. At the end of the year, use an online tax preparation site to help you determine whether the standard deduction or itemized deductions will get you the most tax benefit. It will help you compare both by asking the appropriate questions and giving you a recommendation.
Take a close look at your financial situation, the length and interest rate of your mortgage, and the potential tax benefits before deciding to keep your mortgage just to keep the deduction.