Losing Mortgage Deduction

• If you itemize your taxes, you can deduct interest payments and related fees, such as penalties, on your home loan. When you pay off your mortgage, you cannot take this mortgage deduction. If you have an expensive home or a high interest rate, the mortgage interest deduction can be valuable. For example, if you have a mortgage at 8 percent interest and have most of your income in the 25 percent tax bracket, your effective interest rate is 6 percent. On a $200,000 mortgage, this would be a savings of about $4,000 a year.
  
  

Other Deductions

• The money that you would have used to pay off a mortgage can go to tax planning that saves you even more on your tax bill. If you are self-employed, you can contribute to a retirement plan and deduct it on your Schedule C. This means that you can avoid employment taxes and federal income tax on the contribution. If you pay off your mortgage with money you withdraw from a retirement plan, that money is taxable at your top tax rate.
  
  

Opportunity Cost

• Paying off a mortgage probably is not the most profitable use of your money, because mortgages usually have the lowest interest rate of any loan on the market. Instead, place your extra money in a retirement plan or the stock market, which usually results in a larger return than the interest rate on your mortgage. For example, some employers match retirement contributions, which would result in an immediate 50 percent return on your money.
  
  

Considerations

• If you have a low income, especially when you retire, you probably take the standard deduction and cannot itemize mortgage interest. However, the IRS sometimes offers benefits just for owning a home. For example, the IRS allowed you in 2008 and 2009 to deduct up to $500 in property taxes whether or not you took the mortgage interest deduction or itemized on their tax returns. If you still ponder whether to pay off your mortgage, consider your future financial picture and risk tolerance. You may not want to pay off a mortgage during retirement when you are on a fixed-income and may have to dip into tax-deferred retirement accounts. If you owe more on the mortgage than the value of the home, it might be better to build your nest egg than to pay off a mortgage that may go into foreclosure.