In my recent quest for new financial knowledge, I have noticed a trend that just astounds me: There are a lot of people who claim that paying off your house is a bad financial move because you will lose the tax deduction from the interest you pay.
Most recently, I have been reading “The Last Chance Millionaire” by Douglas R. Andrew, and, according to him, budgeting to pay extra principal on your house is one of the biggest financial mistakes you could make. The alternative? You should, instead, invest the money you would have paid on your house and, in addition, borrow every penny you possibly can from your home equity and invest that as well.
This is an investing method known as leveraging. Essentially, you’re taking money that people in the financial biz call OPM (Other People’s Money) and using it to gain a higher rate of return than what you are paying in interest on your house or other debts.
The problem with this, especially when it comes to the home mortgage, is that the math just doesn’t add up. Yes, it is true that the interest you pay for your mortgage is tax deductible. But that doesn’t make it worth it to continue making payments. Let’s take a look at the numbers:
Pretend you have a $200,000 mortgage. On average, this means that you will pay $10,000 dollars per year in interest, all of which is tax deductible. It is important, here, that you remember that a tax deduction is very different from a tax credit. Where a tax credit is a direct decrease in the taxes you owe, a tax deduction just means that an amount is not taxable. Hence, your $10,000 tax deduction will mean you save about $2,500 off your tax bill.
Sure, it’s nice to save $2,500, but what about the other $7,500? If you were to pay off your mortgage and no longer pay interest on it, you would be paying some extra money on your taxes, but you would be saving three times that much overall. This just doesn’t make sense.
And all of this is in addition to the fact that you would no longer have a house payment. In our above scenario, you wouldn’t just save $7,500 per year because of interest, you would also no longer be required to pay the other $700 per month in principal amounts. That means somewhere in the neighborhood of $15,000 per year in liquid funds for your use.
Still convinced that it’s dumb to pay off your mortgage? Please, tell me why. It sure doesn’t seem like something most millionaires would do.
Photo by woodleywonderworks.