Some Financial Advisers recommend that their clients not pay off their mortgage early because the mortgage interest creates a tax deduction. This is bad advice and the example below that Dave Ramsey uses illustrates why:
Let’s suppose that you have a $200,000 mortgage with a 5% interest rate.
This means that you would pay roughly $10,000 in interest this year ($200,000 x .05).
Now, lets suppose that your income is $50,000 per year and that puts you in a 25% tax bracket.
With the mortgage above, you would be able to take a tax deduction of $10,000, so instead of paying taxes on $50,000, you would pay taxes on $40,000.
In a 25% tax bracket, taxes on $10,000 would be $2,500 ($10,000 x .25). So, having a mortgage saved you $2,500 on taxes. That’s good news, right? Not really. In order to save that $2,500 in taxes, you paid $10,000 in interest to the bank that holds your mortgage.
You swapped $10,000 for $2,500. That is a bad idea!
If you really want the $2,500 tax deduction, then give $10,000 to your church or a qualified charity. The tax deduction is exactly the same as if you had a mortgage, but you did not have to stay in debt and risk your home in order to get it!
Personally, I would stay away from any Financial Adviser who recommends that I keep a mortgage for the tax deduction..