I die a little inside every time I hear someone repeat this myth. Man oh man.
Anyhow, to show you exactly why the income tax deduction isn’t a good reason to keep your mortgage, you’re going to have to stick with me as I go through some calculations here.
Say you buy a $300,000 home. You make a 20% downpayment. You end up with a mortgage of $240,000 that you plan on paying off over 30 years. Your interest rate over the next five years is 3.5%.
Your monthly payments are going to be around $1075/month ($12,900 total in 12 months). The amount of that that goes towards interest payments is about $690/mo — a whopping $8280 total in 12 months.
Now let’s pretend that you either saved up or lucked out and came into a windfall of cash that you could use to pay off your mortgage in full.
Are you better off paying it off to save on all that interest you’re paying to the bank? Or should you keep the mortgage to get the income tax deduction from the interest you’re paying?
Well, let’s run the numbers and see.
Let’s carry on with our game of pretending, and pretend that you pay 25% of your earnings to the IRS for income tax.
If you paid off your mortgage, you’d no longer have to pay $8,280 of your earnings to the bank in the form of interest charges. Instead, you’d be paying the IRS income tax on that $8,280, and if you’re in the 25% tax bracket, you will pay the IRS $2,070.
So what’s better? Giving the bank the full $8,280? Or paying the IRS only $2,070?
Obviously, you’re way better off if you pay off your mortgage, and save all that money that you’d otherwise have been paying to the bank, right?
Hell, even if you’re in the highest tax bracket, paying about 40% of your income in taxes, you’re still way better off paying off your mortgage. Because paying the IRS 40% of $8,280 ($3,312 in taxes) is still a lot better than paying 100% of $8280 to the bank.
So I rest my case. Do not ever, ever, ever make the mistake of thinking that you’re saving money by not paying off your mortgage.
Want to do some calculations that are specific to where you live? No problem. Here’re a handy tax benefits mortgage calculator that estimates exactly how much you’ll save on taxes each year by carrying a mortgage, and allows you to compare that figure to how much you’ll be paying each year in interest payments.
LIE! You should keep your mortgage because interest rates are lower than other types of loans and you can invest the money in the stock market or a mutual fund
Proponents of this idea say it’s the way to go because the amount of interest you’re paying on the mortgage is offset by the profits you’ll make from investing the money in a good mutual fund or similar investment.
Before you jump all over this, do some quick math and see if it’s worth the risk to you. Because the odds are high that it isn’t worth the risk at all.
Let’s say you saved up $10,000 cash and are debating whether or not to use it to pay down your mortgage where you’re paying 3.5% interest or invest it in a mutual fund where you’re told to expect a 7.5% return.
If you use it to pay down your mortgage, you’ll save $350 (i.e. 3.5% of $10,000).
If the mutual fund prediction is correct, you’ll make $750 in profit. So that’s $400 more than what you would have saved if you’d put it down on your mortgage.
But we didn’t take into account income taxes yet. Let’s say this $750 profit is taxed at a 20% capital gains rate. If that’s the case, you’ll pay the IRS $150, and have $600 left over to enjoy.
So now you’re only $250 ahead of where you’d be if you’d put that $10,000 cash towards paying down your mortgage (i.e. $600 profit from investment – $350 savings on mortgage interest = $250).
Maybe that sounds like a good trade to you. But there’s one more thing you need to consider.
If you put that $10,000 towards your mortgage (3.5% interest), it’s a 100% guarantee that you save $350.
But if instead, you put that $10,000 into that mutual fund, it’s not a guarantee that you’ll end up having $600 in after-tax profit to enjoy.
The market could tank.
The prediction of the return you’ll get could be wrong. Maybe the mutual fund only ends up making you $300 in after-tax profit. If that happened, you would have been $50 further ahead if you’d put the ten grand towards paying down your mortgage.
Who knows! Anything could happen.
So unless you’re a long-term, time-tested, exceptional stock or investment fund picker, I recommend that you put that $10,000 cash towards your mortgage.
LIE! There’s nothing wrong with buying furniture, vacations, or electronics with a loan
Here’s the thing. Every single one of these things will go down, down, down in value starting the very second you take them home, and you risk owing more than it’s worth from day one. (Okay, so you can’t take your vacation home, but you get the idea. Once you take that trip, you can’t sell it to recoup any of your money.)
If you’re ever tempted to add to your debt by using credit to buy furniture, a vacation, a new TV, or some other big-ticket electronic item, stop yourself immediately and remind yourself of the cold, hard facts.
- Financing these things with debt almost always means you’ll pay more for it. The next time you’re tempted to finance something like this with debt, calculate how much extra it’ll cost you once you take into account all the interest and fees you’ll pay.
- You don’t need any of these things. You won’t die, get sick, or have any other horror fall upon you if you don’t buy it.
Disliking your current furniture is no excuse. The fact that the upholstery is wearing out isn’t either (because you can patch it yourself or cover it with a blanket/cover until you’ve saved up the cash to replace it).
No one needs a new TV, home entertainment system, stereo, home automation system, smart phone or even a computer — humans survived for eons without these things.
Maybe you’re shocked that I include a computer on that list since I make my living with one. But I can assure you that’s only because I could save up cash to buy one in the first place. Until then, I made do without one. And you can too.
If you need to type up a resume, or a letter, for example, you can simply head over to your local library and do it there. Or ask a friend or family member if you can borrow their computer. Even if you consider the cost of giving them money for the paper and ink used to print your letter or resume, the cost is still far less than that of buying your computer.
If you need to do some online research, most local libraries will allow you to do this for free.
Now on to the topic of vacations. “But I need it to relieve my stress!” some might say. The truth is, there are plenty of ways to relieve stress for free. Local libraries have loads of books on the topic of stress relief — you can learn about using meditation, exercise, and all kinds of other things to relieve stress. And they cost absolutely nothing. Don’t get me wrong; I’m certainly not opposed to vacations. But you have to be able to afford them to take them. If you can’t afford it and take out a loan to pay for it, you’ll only add MORE stress to your life due to the payments you’ll be making long after the fun has ended.
- If you need to finance it with debt, you can’t afford it. Period. There are no and, ifs or buts that will ever make financing this kind of thing with debt a wise decision.
- Even no-money-down, no-interest loans are risky. You see, usually, these kinds of so-called “deals” come with a catch. Maybe it’s a no-payments-for-one-year deal — but part of the deal is that if for any reason you aren’t able to pay it off before the one year is up, you’ll be slapped with extremely high-interest rates until you do.