Ask Money

Mortgage interest vs. mortgage deduction

Chris Farrell Aug 27, 2010

Question: After getting yelled at by my father in law for even suggesting the idea, I’m wondering if paying off our mortgage early is a good decision.

My husband is 37, I am 30, and our first home should be finished by august of this year. We figured out that if we pay 2,400 a month, we can get that sucker paid off in seven years. To be fair, we don’t have much in savings, but my father in laws point is the tax deduction from the interest. But won’t the interest we end up paying be higher than any possible tax deduction we might get?

Both of our cars are new, and paid for. I guess to sum it up, is it better to power down that mortgage and in seven years throw tons of money at investments, or make our monthly mortgage payment, and put more money in savings? Thanks in advance, Summer, Cincinnati, OH

Answer: I don’t agree with your father-in-law. You’re asking a good question. It’s an issue lots of folks are grappling with these days and the answer isn’t easy. It involves weighing a number of financial trade-offs.

But you are absolutely right about the cost of interest versus the tax benefit of the mortgage deduction. I think the deduction is the most over-hyped benefit in the tax code. Yes, it does lower the cost of borrowing to buy a home but that gain is swamped by the real cost of all those interest payments over the years. Fact is, the mythic status of the mortgage deduction has been abused to convince people to borrow too much to own.

So, forget the deduction argument. It isn’t a good argument against paying off the mortgage early. However, I am concerned that you’ll put all your savings into one basket: A home. It’s a risky strategy to put so much money into one asset in one market.

I’d prefer that you build up a diversified portfolio of savings, from savings accounts to CDs to Treasuries to stocks (depending on where you ike to save).. Even when the economy gains some strength and the job market improves plenty of people will face the risk of a layoff, a pay cut, or a forced embrace of part-time work. These are all techniques management uses and will continue to use to deal with economic adversity. In our uncertain economy everyone needs their own personal financial safety net. The savings is also an opportunity fund. Who knows what investment or career opportunity may emerge for you in coming years?

How about a compromise? Instead of siphoning all your savings into the mortgage and paying it off in 7 years, what if you took 12 years? Maybe 10? Perhaps 14? I’d play with the numbers, but this way you can own your home quicker than normal and still add to your savings accounts elsewhere.

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