Pay off mortgage or invest?

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Dear Dr. Don,
The question I have is regarding paying off my mortgage after 15 years of payments on a 30-year, 5.25 percent, traditional fixed-rate mortgage. I was looking for some type of calculator that would break down the advantages of paying off the mortgage. I currently have 1.5 times the cost in savings resources.

I’d also like to know the impact of no longer having the annual mortgage interest tax deduction versus the impact of otherwise investing that money, considering current investment returns (on CDs, savings or mutual funds). There really isn’t a lot of annual interest to be made, although I understand that investment yields could change over the next decade.
— Joe Jump-in

Dear Joe,
As you know, your annual mortgage interest deduction diminishes over time as more of your monthly payment goes to the repayment of principal and less goes toward interest expense. The amortization table available on Bankrate’s mortgage calculator shows that breakdown over the life of the loan, month by month.

My rule of thumb is that it only makes sense to prepay your mortgage if the effective rate on your mortgage is greater than what you expect to earn post-tax on your investments. The more conservatively you invest, the easier it is to make the argument that you should be prepaying your mortgage versus investing. You can estimate the effective rate on your mortgage using Bankrate’s mortgage tax deduction calculator, and you can view a report showing the annual interest expense for each year over the life of the loan.

The issue is whether you are fully utilizing the mortgage interest deduction. If you’re just replacing the standard deduction with your diminishing mortgage interest, you don’t need the mortgage interest deduction to reduce your tax bill.

As you calculate an after-tax, or effective, rate on your mortgage, the assumption is that you can fully utilize the mortgage interest deduction. If that’s not the case, the effective rate on your mortgage is higher, making a stronger argument for prepaying the mortgage.

Talk to your tax professional if you don’t know where you stand with the utilization of the interest deduction.

The closest I came to what you’re looking for in a calculator is an Excel spreadsheet on The Mortgage Professor’s website. The spreadsheet is on loan repayment versus investment. It should help you make your decision. Keep in mind that while you expect investment yields to rise over time, your annual interest expense is falling each year.

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