Why Should I Pay Off The Mortgage?
Laura asks Dave to explain paying off the mortgage versus keeping it for the tax deduction.
QUESTION: Laura on Twitter asks Dave to explain paying off the mortgage versus keeping it for the tax deduction.
ANSWER: If you have the opportunity to pay off your home and you don’t pay off your home in order to keep the tax deduction, that would be an indication that you are poor at mathematics. It’s a nice way of saying you’re stupid and you believe cultural lies that are out there. The cultural lie is never pay off your mortgage because you’ll lose the tax deduction.
Let me help you with the mathematics on this. Let’s use an example. Let’s say you have a $200,000 mortgage at 5% interest. If this is your personal residence and you do itemize—by the way, only 27% of Americans who file taxes itemize—you can write off the interest portion of your payment on your personal residence. If you have a $200,000 mortgage at 5%, that would be $10,000. We have a $10,000 tax write-off because we have a $200,000 mortgage at 5%. That’s a tax deduction, meaning if that couple makes $75,000 a year and they take a $10,000 tax deduction, they don’t pay taxes on $75,000. They instead pay taxes on $65,000. If you do this weird Dave Ramsey thing, though, and you pay off the house, you no longer pay taxes on $65,000 because you would not have a tax deduction. You’d have to pay taxes on $75,000. You’re in a 25% tax bracket if you make $75,000 a year. That $10,000 a year that we’re talking about is taxed at 25%. By paying off your home, 25% of that $10,000 that you’re going to have to pay extra taxes on is $2,500. In essence, you lost a $2,500 savings on your tax bill, but you gained $10,000 by not having to pay it to the bank.
A $10,000 tax deduction is the same thing as saying, “I would rather give Countrywide $10,000 than give the government $2,500.” I’m not fond of giving the government money, but I think that that’s a pretty stupid trade, by the way. If you’re so dumb that you think giving Countrywide or Wells Fargo or whoever your mortgage company is $10,000 to avoid a $2,500 tax bill, you flunked math in the third grade. That’s stupid. I used to be that stupid. I believed that same mythology that a lot of you believe.
Here’s another idea. What if, instead of a $200,000 mortgage creating a $10,000 tax deduction, you wanted to trade $10,000 and save $2,500, why don’t you just give an extra $10,000 to your church or to the Red Cross? You don’t have to be in debt $200,000 to trade $10,000 for $2,500. You could do that just by increasing your charitable giving. Where are all these financial sophisticates who are suggesting that a mortgage is somehow financially sophisticated? Where are these sophisticates when it comes to saying increase your charitable giving? It’s the exact same mathematics as having a tax deduction on your mortgage. We live in the land of doofuses. That’s where they are. It’s what’s known as the blind leading the blind. The stupid leading the stupid, and I’ve been one of them. I’m not saying I’m above it. I’ve made these exact same mistakes. It was an old farmer in bib overalls who taught me that, and I’ve got a finance degree. Apparently, I didn’t learn much at that college. And apparently some of you CPAs didn’t if you’re suggesting people keep debt solely because a tax deduction is somehow mathematically a good deal. It’s not a good deal. Do not keep a mortgage to call yourself sophisticated. Bad plan.
Now if you’ve got a mortgage, until you get it paid off, for goodness’ sake, take the tax deduction. But don’t stay in debt telling everybody how smart you are.
Make your next home purchase a smart one by paying cash or sticking with a 15-year, fixed-rate mortgage. To really knock it out of the park, keep your monthly payment to no more than 25% of your take-home pay.
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