Should I pay off my mortgage?

Is Paying Off Mortgage the Way to Go?

Owning a home is the American Dream. It gives you the feeling of accomplishment. You wait for the day when you can write the last check to pay-off your mortgage. But then you just realized, if you pay-off your home then you will lose your tax benefits. You want to payoff your home but at the same time you don't want to lose your tax benefits.

The mortgage interest deduction is being preached hard by most Realtor and loan officers to their clients. If you look closely at the numbers, the deduction does not add up to give you a  real benefit. If you do your own taxes, you will be aware that the IRS have already given you a standard deduction and for 2013 tax year the standard deduction for married couple is $12,200.

     Source: IRS.GOV  

Below is the list of common deduction that you can claim on your taxes if you decide to itemize. I will give some value that represent a typical family who owns a home. 

1. Out of pocket medical and dental expenses: You can deduct expenses when it is greater than 7.5% of your income. Most people don't benefit on this: (very rare)
2. State and local taxes paid: (1,200)
3. Real Estate taxes: ($3,300)
4. Gift to charity (i.e. Salvation Army, churches) : (let say $6,000)
5. Casualty and Theft Losses (very rare): 
6. Job Expenses and Misc. Deductions greater than 2% of earned income. (rare)
7. Mortgage Interest Deduction: ($3800) let say mortgage balance of $120,000 at 3.5%

In this example,The itemized deduction, will be $14,300 that is $2,200 higher compare to the standard deduction.   

Below shows the IRS income tax bracket for the year 2013.

    Source: Forbes

Let say the family earns $90,000 that will put them into 25% tax bracket. With the above itemized deduction of $14,300 This family's MAGI will be $75,700.

If the family itemized their deduction their tax liability will be $10,782.50

  - $9,982.50 + 800 or 25% of the excess over $72, 500 ($75,700 - 72,500 x 25%)

If the family takes the standard deduction their tax liability will be $11,357.50

This family will save $575 in taxes by paying $3,800 to the bank. If they don't have a mortgage payment therefore taking only the standard deduction, they will not get the $575 tax refund but they also don't have to pay $3,800 to the bank. So by owning the home free and clear, they are ahead by $3,225.   

What if having a higher morgage deduction takes me to the lower tax bracket? 

Let us say there is another family who also earns $90,000 but buys a bigger house and pays $10,000 in mortgage interest with all the deduction the same as the above family?  Their MAGI would fall to $69,500 which will bring down their taxable rate to the lower level of 15% 

If the family Itemized their deduction their tax liability will be: $9,532.50

   = $1,785 + $7,747.50 or 15% of excess over $17,850 ($69,500-17,850 *15% )

If the family takes the standard deduction their tax liability will be $11,357.50 same as the family above

This family will save $1,825 in taxes by paying $10,000 in mortgage interest for a net loss of $8,175. In any day, I will be happy to take the $10,000 and give $1,825 to the IRS not the other way around.

As you can see, having a paid off home is better on both scenario. A paid of mortgage will also comes with peace of mind and bigger cash flow for you that you can use to fund your retirement and your children's college expense.