Common logic in this country goes something like this: “Since I’m able to deduct my mortgage, I should keep it as long as possible, so I’ll pay less taxes.”

On the surface this makes sense. It’s true – there’s a chance you’ll have a smaller tax bill if you have a mortgage than if you don’t. However, once you dig a little deeper, this logic doesn’t hold up.

Only mortgage interest is deductible.

First, let’s be clear that you only get to deduct the mortgage interest on your taxes. You never get to deduct the principal. This means you’re not able to deduct the full amount of your mortgage payment. As time goes on, each payment is allocated more towards principal and less towards interest. This means that your deduction decreases each year that you continue to pay the mortgage.

Do you itemize?

Second, to save taxes from your mortgage interest, you need to itemize deductions. Under the 2023 tax code, the standard deduction for a married couple is $27,700 (or $13,850 for single filers). To benefit from mortgage interest expense, your itemized deductions need to add up to more than the standard deduction. Itemized deductions include things like charitable contributions, state income taxes, mortgage interest, and medical expenses (in rare cases). The vast majority of filers don’t itemize deductions because they don’t have enough of them to eclipse the standard deduction. Bottom line: If you don’t itemize deductions, you get absolutely no tax savings from your mortgage interest.

The math…

Now let’s look at the math if you actually itemize deductions, and therefore get the tax savings that everyone talks about.

Let’s assume you earn $100,000/year and have a $400,000, 30-year mortgage at 5%. Your monthly payment is $2,147 (principal and interest), so your total annual cost is $25,764. In year one of the mortgage (where your interest expense, and therefore your tax deduction, is highest) you’ll pay $19,866 in interest.

With no mortgage payment, your federal tax bill is $8,236. With your mortgage, your tax bill is $5,852. Look at that! By paying your mortgage each month, you saved $2,384 in taxes!

But… you had to pay $25,764 in cash to save $2,384 in taxes.

I’d rather pay the additional $2.4k in tax and pocket the $25.8k in mortgage payments. In this situation, you’d have $23,380 in actual cash more than carrying the mortgage, even after your tax savings.

In conclusion,

There are a lot of reasons why a mortgage can make sense, but keeping a mortgage to reduce your tax bill isn’t one of them.

These are the opinions of Legacy Wealth Management, LLC and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Dan Funderburk is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice. Copyright ©2023 Dan Funderburk. All Rights reserved. Commercial copying, duplication or reproduction is prohibited.