If I pay off my 3% mortgage, should I consider it to be the equivalent of buying a risk-free bond at 3% as I’m foregoing the tax deductio…

Answer by Wray Rives:

There are a lot of variables here and we have to make some assumptions , but if you are writing off the mortgage interest for tax purposes and assuming you are in an effective 20% tax bracket, then the mortgage is costing you 2.4% net of tax.  That means paying off the mortgage would be equivalent to investing in a 2.4% tax exempt bond. If you can get better than a 2.4% tax free return (or net after tax return for that matter) on money invested, then you should not pay off the mortgage and invest those funds instead. If you get less than a 2.4% return, pay off the mortgage

I don't know your specific facts, so I can't say if there are other variables that may impact your decision, but some common issues you want to consider as they may change the answer are:

  • Potential of AMT on tax exempt income
  • Potential that bond interest could still be taxable for state taxes
  • Potential that without mortgage interest you don't have enough deductions to itemize and loose the tax benefit of other tax preferred expenditures.
  • Potential that you also have tax deductible PMI on the mortgage
  • Potential that if you are in a higher tax bracket the deduction is more valuable to you and lowers the effective cost of the mortgage or conversely if you are in a lower tax bracket the deduction is less valuable to you.

If I pay off my 3% mortgage, should I consider it to be the equivalent of buying a risk-free bond at 3% as I'm foregoing the tax deductio…