Mortgage Interest is deductible but...

  In talking with people about the Home Ownership Accelerator, I am often confronted with the question "Won't I lose my tax deduction for mortgage interest if I pay off my mortgage early?".  The answer is always "Yes, you will but, that's a good thing."  The reason is clear once you understand what a deduction actually is.

You are very good at what you do for a living and you are confident that your CPA or Turbo Tax are good as well.  You provide them with whatever information they ask for and then trust them to prepare your return.  When it comes time to file your return, you only look at two lines.  Line 73 is the amount you overpaid or your refund.  Line 76 is the amount you owe.  You then either write a check or wait for one.

I have also become aware in conversations with clients that they believe that their mortgage interest that they paid reduces the amount they owe dollar for dollar and that is what I am trying to clear up here.  Your CPA or software computes your adjusted gross income on page 1 of the 1040 and shows it on line 37.  This amount is carried over to page 2, line 38.  Your mortgage interest is recorded on line 10 of a separate form (Schedule A).  Then the total itemized deductions on Schedule A are recorded on line 40 of your Form 1040.  Line 41 is Line 38-Line40.  One more fuzzy calculation on Line 42 (that may or may not apply to you so, I won't get into it) and you have your taxable income. 

The amount of mortgage interest you pay directly reduces your taxable income and only indirectly the amount you owe.  So quick example and I'll wrap this up.  If you paid $10,000 in mortgage interest in a calendar year and your tax bracket is 28%, you save $2,800 on you total taxes. 

So, it's nice to be able to deduct it but, let me put it another way.  Would you invest $10,000 in anything that was guarateed to be worth exactly $2,800 a year later?  You bought your home because you wanted to own rather than rent so, doesn't it make sense for you to take control of precisely when you stop renting the money too?