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When discussing buying a home I often hear people say they like having a mortgage because they get the benefit of writing off the interest. Am I misunderstanding something? My simple thought is if you are paying $100 in interest to save $25 in taxes (simple example of having a 25% tax rate), wouldn't paying off the mortgage be more beneficial, and have $75 and pay $25 in taxes later?

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What does your question have to do with insurance (mentioned in the title)? Also, can you clarify what scenarios you're comparing? Usually when I hear people talking about the "benefit" of a mortgage, it's compared to renting, not to paying off the entire mortgage right away (which is often not financially feasible). –  BrenBarn Jul 23 at 2:20
    
Sorry I corrected the title. I suppose I'm comparing to just paying the minimum payment on a mortgage with the thought of having the interest deduction as a benefit, vs paying off the mortgage aggressively, not necessarily right away. –  Jacob Jul 23 at 2:28
    
Because I can trivially make more on the stock market than the 3% mortgage interest I pay. –  Joshua Jul 23 at 18:53
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@Joshua That might justify why one would choose to borrow versus buy out-right, but I'm not sure it makes sense to borrow just to get a tax write-off on the interest. The OP is right that it's like paying $100 to save $25. –  Brandon Jul 24 at 1:33
    
Just to be clear the question as not a mortgage vs rent issue. It was simply brought up in several conversations without someone being able to provide details on why (other than that's what they heard). I prefer to try to understand the details behind a thought and this thread has provided some context. Thanks. –  Jacob Jul 30 at 21:07

12 Answers 12

Because "my accountant said I'm in the 28% bracket and need more write-offs." When I hear someone say this I tell them to get a new accountant/advisor/tax guy.

The benefit, if any, is the fact that if, and only if, (a hat tip to @staticx) you are already itemizing your deductions.

It means that for me, my 3.5% mortgage is really costing me 2.625%.

The only effect of this is the when I line up my debts, the mortgage might fall to a lower priority for payback. This is where there's a balance between the choice of a robust emergency fund, earning close to 0% today, or using those funds to pay the mortgage at an accelerated rate.

If the sentiment expressed by the question implies that one should carry a mortgage, needed or not, it really comes down the a question of risk over the long term. I don't suggest that people take a mortgage today to invest in the market. A zero return as we just saw in the '00s will show you that the 10% market return is an average over the very long term. FWIW, the '96-'05 period returned 9.08%, and '06-'13 (2 years short of the 10) 7.26%. Few have the discipline to patiently wait out the dips and see the returns I quoted.

That said, the fact that the interest is deductible is a small factor given the low rates we are currently enjoying.

Each of the points above can be expanded into its own answer. A great question with not-so-simple answers.

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Love the opening paragraph. –  Pete Belford Jul 23 at 14:12

Certainly, paying off the mortgage is better than doing nothing with the money. But it gets interesting when you consider keeping the mortgage and investing the money. If the mortgage rate is 5% and you expect >5% returns from stocks or some other investment, then it might make sense to seek those higher returns.

If you expect the same 5% return from stocks, keeping the mortgage and investing the money can still be more tax-efficient. Assuming a marginal tax rate of 30%, the real cost of mortgage interest (in terms of post-tax money) is 3.5%*. If your investment results in long-term capital gains taxed at 15%, the real rate of growth of your post-tax money would be 4.25%. So in post-tax terms, your rate of gain is greater than your rate of loss.

On the other hand, paying off the mortgage is safer than investing borrowed money, so doing so might be more appropriate for the risk-averse.

* I'm oversimplifying a bit by assuming the deduction doesn't change your marginal tax rate.

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A huge assumption built into this is that you are currently itemizing your deductions and all your mortgage interest would be in addition to already itemized deductions (which must exceed the standard deduction). Fortunately other answers address this. –  enderland Jul 23 at 12:37
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+1 the math is right. The issue is one of risk. A 5% fixed 'return' on the pre-payments vs even the 10% long term market with a 14% standard deviation. If one started this process in 1999, at the end of that next decade, the results wouldn't have been so great. Yet, add 5 years to either end, and good results emerge. –  JoeTaxpayer Jul 24 at 13:20

I believe this argument is most often used when considering which debts to pay back first, or when there are other options available such as investment options, building up an emergency fund, or saving for a large purchase.

In that case, it's simply justifying making minimum payments and paying more over the life of the loan in exchange for larger liquidity in the present.

Unfortunately, when it comes to choosing between which debts to pay (e.g. My mom pays more than the minimum on her car because she can't deduct auto loan interest, despite her mortgage carrying a higher interest rate), it's only beneficial if the tax savings offsets the interest savings difference.

The formula for that is:

tax bracket > (1 - (target loan interest rate / mortgage interest rate))

That said, most people don't think in the long term, either by natural shortsightedness, or by necessity (need to have an emergency fund).

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When repaying the loan with the highest interest, you should use the net interest rate after any deductions (tax or otherwise). That's generally easier to calculate, especially if you have multiple loans. You can calculate the net interest rates for each loan independently. –  MSalters Jul 23 at 8:10
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As far as mom is concerned, she might also do this because it feels like she can free up that monthly cash sooner. Keeping an open mind, I've heard people say they know they'll pay more in interest over time, but freeing up say $200/mo offers them a good feeling and help with their budget even when the other loan might be a higher rate. –  JoeTaxpayer Jul 24 at 1:57

When discussing buying a home I often hear people say they like having a mortgage because they get the benefit of writing off the interest.

I assume this is the United States.

You need to also consider that many people can take the standard deduction of about $12k for married couples filing jointly, so even if they itemize the interest, it would only make sense to 'write it off' if you are able to itemize deductions greater than the standard deduction:

Table of standard deductions

Source: http://www.forbes.com/sites/kellyphillipserb/2013/10/31/irs-announces-2014-tax-brackets-standard-deduction-amounts-and-more/

So some people will input the mortgage interest and other related deductions into the computer only to find out that their itemized deductions don't add up.

Where it benefits people sometimes is if they have medical bills which are greater than 10% of their income in addition to the mortgage interest. So it benefits them to itemize. There are other major sources of itemization but medical bills are very common. Other common items are auto registration taxes or interest from student loans.

It is going to be situation dependent, but if you are within a few years of paying off the mortgage it would make sense to make micropayments to accelerate the payoff date. If you have 30 years to go, it would make more sense to generate an emergency fund, pay off a car, or save up for other things in life than worry about paying off a mortgage. Take the benefit of deducting the mortgage interest if you can, but I imagine that many people would be surprised to hear that it's not always black and white.

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I think, generally speaking, people who say things like that don't have a firm grasp of their finances.

On the other hand, if you take a mortgage as a vehicle for leveraged investment the interest can pay for itself in gains made elsewhere.

Paying mortgage interest is otherwise only good for the banks, but our system reinforces the idea that everyone should be in debt instead of profiting from their capital.

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Paying mortgage interest is otherwise only good for the banks... It'd be interesting to see any math treatment to support that. One could save money for 15-20+ years to see if a cash buy was possible, but that's possibly only rational if one can live rent-free for that period. –  user2338816 Jul 24 at 13:13
    
The math depends very heavily on your zip code; it would be pretty silly to try to solve it here. In any case, the interest is never helping you, always helping the banks, and typically taking the place of the tenant fees which also do not help you, and always help the landholder. –  user10042 Jul 24 at 16:33
    
The math should be exactly the same regardless of zip code; variable values can be looked up as needed by anyone. In many (most?) cases, the outgoing rent will more than offset any interest advantages simply because it covers landlord profits. Where it's significantly questionable is in a period of a badly declining market where there is a drop in property value; but that'll similarly cut the value from a cash buy also. Outside of such a period, any increase in property value is leveraged for a mortgage purchase. –  user2338816 Jul 25 at 2:01
    
@user10042 is absolutely correct that the interest is only helping the bank. The fact that the bank was willing to loan you the money to buy a house so that you don't have to rent or live in a cardboard box under a bridge is helping you. But if a bank offered you a choice of a loan at 5% or a loan at 0% with otherwise identical terms, I can't imagine why you would take the 5%. –  Jay Jul 25 at 20:49
    
Sorry to play the devils advocate here, I thought banks benefited more from money we saved a la federal capital requirements. If someone saved 250k in an account, a bank could issue 10 250k mortgages, correct? –  user14218 Jul 29 at 23:23

As @BrenBarn points out, when people say "they like having a mortgage because they get the benefit of writing off the interest" they typically mean as opposed to renting. You can deduct interest and real estate (property) tax payments, as well as some closing costs in the year you purchase the home. You are also building equity (instead of helping your landlord build his or her equity).

Take for example a single person paying $1,000/month to rent an apartment. This is not deductible. He has $1,800 a year in other expenditures that would otherwise be deductible (charitable contributions, etc.), but he doesn't itemize because it isn't more than the $6,100 standard deduction, so it doesn't matter.

He takes out a mortgage for $150,000 at 6% over a 30-year term to buy a similarly-appointed home. His new mortgage payment is about $900/month, plus he puts $100/month into an escrow account for property taxes, roughly totaling his former rent payment. Over the first full year, he pays about $9,000 in deductible mortgage interest and $1,200 in deductible real estate taxes. And because he is now itemizing, he can also write off the aforementioned $1,800. At a top marginal tax rate of 25%, he shaved nearly $1,500 (.25 * (9000 + 1200 + 1800 - 6100)) off his federal income tax bill -- with the same living expenses!

This is a simple example with some arbitrary numbers to prove the point, and there are a lot of other pros and cons to buying vs. renting. But again, this is probably what they mean when you hear this. Others have covered the overpaying angle, and there are a bunch of other Money.SE posts on the same or similar subjects.

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With no PMI mentioned, I trust this was a 20% down purchase. $190K house. Real estate taxes vary. By me, this would be closer to $3000. It's easy to contrive examples where buying is preferable to renting. I don't know if that proves a point or simply illustrates that one can look at the rent/own ratio and choose which is best based on that number. But, the question wasn't about that. It started with "liking a mortgage" as compared to buying with cash, or staying mortgage free after paying it off. –  JoeTaxpayer Jul 29 at 21:26
    
That's a very narrow interpretation of a very vague question. "What does it mean when people say..." I stated that it was a contrived example. And if you're going to quibble, it would have been a $187.5K house. –  mwp Jul 30 at 19:27
    
Actually, I thought I was agreeing with you that the numbers might work as you suggest, only that it's not always the case. By the way, the house was $190K, and his wife convinced him to not get a mortgage above $150K. So it was a bit over 20% down. –  JoeTaxpayer Jul 30 at 20:09
    
LOL! Fair enough. :-) –  mwp Jul 30 at 20:43

Aggressively paying of Mortgage is better. If you have more cash available [assuming you have covered all other aspects i.e. emergency funds, retirement etc], the only question you need to ask is where will you invest and what returns would you get.

So if your mortgage is say at 5%, if the spare money can get you more than this, its beneficial, if its in Bank CD with say near zero interest, its not worth it. However if you are sure you can make 10% returns on the investments, then go ahead and don't pay the mortgage aggressively.

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If you take the statement you quote as stated, it is indeed absurd. Unless you have a really creative tax accountant or live in a country with very unusual tax laws, any tax deduction you get for mortgage interest is going to be less than the interest. You don't come out ahead by getting a $25 deduction if you had a $100 expense to get that deduction.

Where there can be some sense behind such a statement is if you consider the alternative to paying cash for a house or making extra payments against a mortgage. If you had $100,000 in cash in a box under your bed, and the choice is between, (a) use that $100,000 to buy a house in cash, or (b) borrow $100,000 at 6% interest and leave that cash in the box under the bed, than clearly (a) is the better choice because it saves you the interest expense. But if the choice is between, (a) buy a house for $100,000 in cash and borrow $100,000 at 6% to buy a car; or (b) borrow $100,000 at 6% interest to buy a house and use the $100,000 cash to buy the car, (b) is the better choice. The home mortgage loan is tax deductible; the car loan is not.

As others have pointed out, if instead of using some extra cash to pay down the principle on your mortgage you used that money to invest in the stock market, it is likely that you would get better returns on the investment than what you would have saved in interest on the mortgage -- depending, of course, on how the market is doing and how well you pick stocks. But the key issue there isn't the tax deduction, it's the comparison of the profits from the investment versus the opportunity cost of the money that could have been saved on the mortgage interest. The tax deduction affects that comparison by effectively reducing the interest rate on the mortgage -- your real interest expense is the nominal interest minus the deduction -- but that's not the key point, just another number to plug in to the formula.

By the way, given the complexity of U.S. tax law, I would not rule out the possibility that there could be some scenario where you really would save money by having mortgage interest. There are lots of deductions and credits that are phased out or eliminated as your income goes up. Perhaps you could find some set of tax laws that apply to you such that having an additional $1000 in interest expense lets you take a $300 deduction here and a $500 credit there, etc, and they add up to more than $1000. I don't know if that could actually happen, but the rules are complicated enough that, maybe. Any tax accountants here who can come up with such a scenario?

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I think the logic in your example demonstrates it is silly to make a decision for tax benefits alone. Saving 75 is much preferred to a cash outflow of 100 less tax savings of 25.

To answer your question, paying mortgage interest represents the fee for the cheapest money most people will ever access, which in itself is a benefit (e.g. renting vs buying). The benefits are maximized when the aggregate of appreciation, inflation, tax savings exceeds total interest expense.

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You hit some good points. The last sentence misses the imputed rent. If the price is right, the interest cost may be below the cost to rent, and any appreciation, an extra benefit. It's all about the purchase price. –  JoeTaxpayer Jul 30 at 0:35

Here is the thing if in 2020-2040 you can buy CD's that pay 4% then you would kick yourself for paying your mortgage early and costing you a no risk 1% revenue on your money.

Think about this? You have a 4% mortgage that is costing you less than 3% after tax deduction"

in 2025 you are buying 10 year notes at 7% which is not out of the question.

You will be making 4% on your money with virtually no risk.

Personally I agree with JoeTaxpayer. I have gone a step further and done so with two houses and I netted myself over 20 grand in 30 months.

So in short you have to ask yourself "Can I make more than 3% on my money?"

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This strategy may be effective some of the time, but there are good reasons people choose to be more cautious in their risk tolerance profile when their homes could be seized after a bad bet on the market. If you don't believe this you must not have been in the stock market during the 3rd quarter of 2008. –  Nathan L Jul 23 at 21:27
    
I tend to get wordy, so not sure which aspect of my answer you agree with, but +1 for doing so. –  JoeTaxpayer Jul 23 at 21:46

If this is an issue of opportunity cost then there is a benefit.

Mortgage interest rates are extremely low, low enough that they can effectively be used to indirectly fund investments.

If one stores equity in a house, ie "pays it off", then that wealth returns only the rate of growth of the house less expenditures.

If one borrows against the house to fund investments, then the above stated returns which on average exceed the mortgage interest rate can be augmented by the investments, yielding a greater return.

The tax benefit is more of a cherry on top.

If one is using this as a justification to spend then it is frivolity.

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The advantage of having a mortgage rather than borrowing money in other ways is that it is cheaper because the loan is secured against the value of the property. If you stop paying then the bank take the house and can sell it keeping what they are owed and returning any excess.

If you have enough money to pay it off then you do not need the mortgage. They normally run for 25 years. It is a lovely day when finally you realise that you own the whole house and no longer owe anything to the bank and the charge against the house is removed and the record of it removed from the land registry.

When you sell a house with a mortgage the buyer has to check that the bank has been paid off before they accept the property.

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Welcome to Money.SE. You don't mention interest at all. How are you answering the question? (Note, the downvote is not mine. I don't welcome with a DV.) –  JoeTaxpayer Jul 23 at 11:44

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