Tuesday, July 3, 2007

Why You SHOULD Pay Off Your Home Mortgage Early

It is amazing how many people believe that you should not pay off your home mortgage so that you can take advantage of the tax savings.

Whenever I mention that I plan to pay off my mortgage early someone will invariably tell me that I shouldn't do it. Some of these people themselves only have a vague notion of why they believe it is a bad idea to pay it off. Keeping your mortgage to take advantage of the tax savings is so common an opinion that many people view it as a fact and are shocked that I would be ignorant of this fact.

While it is true that the interest you pay on your home mortgage is tax deductible, sometimes people forget exactly what that means.

Let's take a look at the numbers. For the sake of simplicity, let's say you have a mortgage of $200,000 at an interest rate of 5%. So, each year you are paying the bank $10,000 in interest.

So, what happens at tax time? At tax time you would get to deduct $10,000 from your adjusted income. However, this does not mean that you are saving $10,000 off your taxes. Depending on your tax bracket, you are only saving a percentage of this amount. Let's say you are in the 25% tax bracket. You would then be saving 25% of $10,000 - or $2,500.

So, what really happened in this scenario? You sent $10,000 to the bank so that you wouldn't have to send $2,500 to the government? Doesn't make sense to me.

I'm going to keep my plan of paying off my home mortgage early!

This article was included in the Carnival of Personal Finance #108 over at Broke-Ass Student.