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There’s no denying the appeal of having no debt, particularly when it comes to your house. However, before you dive into the early mortgage payoff pool, evaluate the financial benefits against any potential tax ramifications. Let’s examine the advantages and disadvantages of keeping your mortgage for tax purposes as we delve into the world of mortgages and taxes.
The Tax Advantage: A Sweet Deduction
Owning a home has many benefits, chief among them being the large tax deduction on your mortgage interest. With this deduction, you can drastically lower your taxable income, which will result in a smaller tax payment and more money in your pocket. There are restrictions on the amount you can deduct depending on your loan amount and filing status. The deduction only applies to the interest component of your mortgage payment, not the principal.
The Investment Opportunity: Putting Your Money to Work
While the tax deduction is enticing it’s not the only factor to consider. Remember, paying off your mortgage early frees up that money for other potential investments. If you can find an investment that offers a higher return than your mortgage interest rate you could potentially come out ahead in the long run.
Navigating the Risk-Reward Spectrum
Investing always involves a certain level of risk. The stock market, for example, can be volatile, and there’s no guarantee that your investments will outperform your mortgage interest rate. However, historically, the stock market has offered higher returns than most mortgage rates.
The Power of Numbers: A Tale of Two Strategies
Let’s illustrate the potential outcomes with a hypothetical scenario. Let’s say you have an extra $210 a month. You are considering investing in the stock market or paying off your mortgage. Over a 30-year period, here’s what could happen:
- Scenario 1: Paying Down the Mortgage Early
This strategy could shorten your mortgage by four years and free up your income for savings later on. However, you would miss out on potential investment gains.
- Scenario 2: Investing the Extra Money
This strategy could lead to higher savings after 30 years, especially if the stock market performs well. However, there’s a chance that your investments could underperform, resulting in lower savings compared to paying down your mortgage early.
The Verdict: A Tailored Decision
Ultimately, the decision of whether to keep your mortgage for tax purposes depends on your individual circumstances. Consider factors like your risk tolerance, investment goals, and tax bracket. If you’re comfortable with taking on some risk and believe you can find investments with higher returns than your mortgage interest rate, then investing your extra money might be the way to go. However, if you prefer a guaranteed return and value the tax deduction, then keeping your mortgage could be the better choice.
Additional Considerations: A Few More Nuggets of Wisdom
- Tax Rates and Deduction Limits: The value of the mortgage interest deduction depends on your tax bracket. Higher earners benefit more from the deduction. Additionally, there are limits to how much mortgage interest you can deduct, so make sure to research the current regulations.
- Alternative Investments: While the stock market is a popular investment option, there are other less risky alternatives that could still offer higher returns than your mortgage interest rate. Consider bonds, real estate, or other investment vehicles that align with your risk tolerance.
- Psychological Factors: Some people find comfort in being debt-free, even if it means sacrificing potential investment gains. Others prefer the flexibility of having more cash on hand. Weigh the psychological benefits of each option when making your decision.
The Bottom Line: An Informed Choice
Paying off your mortgage early or keeping it for tax purposes is a personal decision with no one-size-fits-all answer. By understanding the potential tax benefits, investment opportunities, and your own risk tolerance, you can make an informed choice that aligns with your financial goals. Remember, there’s no right or wrong answer, just the best option for you.
How much mortgage interest can be deducted?
If the mortgage was taken out before Oct. 13, 1987, there is no cap or no upper limit.
If the home was purchased between Oct. 13, 1987 and Dec. 16, 2017—mortgage interest paid on the first $1 million in debt incurred by single or joint filers is deductible ($500,000 for married filers filing separately).
For mortgages taken out since Dec. 16, 2017, if you are filing jointly or as a single, you can only deduct the interest on the first $750,000 ($375,000 if you are filing separately). Note that if you were in contract on or before Dec. 15, 2017, but the mortgage closed before April 1, 2018, your mortgage is regarded as having been purchased in December 2017, and you are eligible to deduct mortgage interest from your taxes up to the million-dollar loan threshold.
Whatever the amount, bear in mind that it applies collectively to all your home-related debt. Put another way, if you and your spouse took out a $100,000 home equity loan and a $500,000 mortgage in 2018 and 2021, respectively, you are $160,000 short of the $750,000 loan amount cap and have a total debt of $600,000. Mortgage Example of mortgage interest deduction.
Assume that you paid $26,000 in interest on your mortgage last year. This is approximately what you would have paid if you were making the median monthly interest payments in 2023. You might be able to deduct the mortgage interest if your yearly salary is $130,000, which would reduce your taxable income to $104,000.
Is mortgage interest tax-deductible?
In a nutshell — yes. But let’s be clear. We’re talking about the interest portion of your mortgage payment that you make each month. The deduction is not available for the down payment, mortgage insurance premiums, or the principal amount of the mortgage (after tax year 2021). With the exception of discount points, which you pay to lower your interest rate, the majority of buyer closing costs are also non-refundable.
Claiming mortgage interest on taxes also requires you to itemize your deductions. The mortgage interest deduction calculator on Bankrate can help you determine what kind of savings you might anticipate when you file.
Why The “Tax Benefit” Isn’t Worth Keeping A Mortgage
FAQ
Is it worth claiming your mortgage on your taxes?
Is it better to pay off a mortgage or keep it for tax purposes?
Is there a tax benefit to having a mortgage?
Do I have to add my mortgage to my taxes?
What are the tax savings of having a mortgage?
The tax savings of having a mortgage come in the form of a tax deduction in the amount of your mortgage interest for the year. This means that the more you borrow, and the higher your interest rate, the larger the deduction you’ll be able to claim, if you qualify.
Do you qualify for a mortgage interest tax deduction?
For homes purchased after the above date, the allowable mortgage interest tax deduction drops to interest paid on the first $750,000 for single and joint filers and to $375,000 for married couples filing separately. (Note: If you purchased your home after Dec. 15, 2017, you might qualify for an exception.
Should you pay off your mortgage or keep it?
However, some forms of debt, such as a home mortgage, have tax benefits that disappear when you pay them off. Deciding whether to pay off a mortgage or keep it for the tax savings it offers comes down to the details of your financial situation and your predictions about the future.
Does mortgage interest reduce taxable income?
Even if you do itemize, your taxable income is only reduced by the difference between the two. If your itemized deductions are $100 more than the standard deduction, that mortgage interest is only reducing your taxable income by $100. 3. The cost of the interest is always more than the tax savings.