Effect of prepaying mortgage on taxes
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 Dear
Dr. Don,
How would prepaying my mortgage affect my taxes? I've read several articles in reference to "prepaying mortgage" not being a good idea. My dream is to be mortgage free and own my home outright. Is this a nightmare instead of a dream?
-- Eileen Equity
 Dear
Eileen,
If you use the mortgage interest deduction on your income taxes, then prepaying your mortgage reduces your interest expense, and by doing so, that interest deduction. IRS Publication 936, Home Mortgage Interest Deduction, has everything you need to know about that deduction.
Not everyone who owns a home can use the mortgage interest deduction, and where the mortgage interest expense doesn't do much more than replace the standard deduction, prepaying the mortgage only has a marginal impact on their taxes -- the margin being the difference between itemized deductions and the standard deduction.
Your goal to be mortgage-free isn't a nightmare. Keep
the dream. I think that it's a great goal for homeowners to have
the house paid off before they retire. What I counsel is to not
abandon other financial goals, such as retirement savings, to focus
solely on paying off the house.
My rule of thumb is, if you expect to earn more on
your other investments, on an after-tax basis, than the effective
(after-tax) rate on your mortgage, then don't prepay your mortgage.
For example, if you're skipping out on contributing to a 401(k)
plan and missing the company match, you should be contributing to
the 401(k) up to the limit of the company match before
making any additional principal payments on your mortgage.
I like the Mortgage Tax Savings Calculator on the
CCH
Web site to estimate the rate after tax.
To ask a question of Dr. Don, go to the "Ask
the Experts" page and select one of these topics: "financing
a home," "saving & investing" or "money."
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