Archive for Thursday, March 27, 2008

Q: Pay off debt? A: Yes

Tax deduction no reason to retain mortgage

March 27, 2008

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Even before the recent economic mudslide, the inbox for my regular online chat filled up with questions from people wondering how to get out of debt or seeking assurances that they weren't the crazy ones in trying to pay off loans aggressively.

The following is a transcript of a recent discussion with some of these questions:

Q; My mortgage is relatively small and I have a good interest rate, but I would like to pay it down as soon as possible and be completely debt-free. When the issue comes up, people always tell me to hang on to the mortgage, arguing the merits of tax deductions, earning interest on the money that's freed up, etc.

None of that moves me (as I know it doesn't move you), but instead of launching into a detailed explanation about why being debt-free is preferable, I'd rather have a short, succinct comeback. Any ideas on how to respond?

How about this: "I don't like being a slave."

If they don't get it, they don't get it.

You see, you are up against years and years of brainwashing. People believe that they should take a mortgage to their grave because that's what lenders want them to believe.

But you are a slave when you borrow money.

And the tax-deduction issue drives me nuts. I'll use a very simple example. Let's say you spend $1 in mortgage interest a year. You are in the 35 percent tax bracket. Simply put, you spend a buck to get 35 cents back.

But what if you kept your dollar (meaning you had no mortgage and thus no interest payments). Yes, you may have to pay 35 cents in taxes but which is higher - 65 cents or 35 cents?

If you pay off your mortgage, there are other things you can claim if you are just dying to have a deduction. Give the 35 cents to charity.

Re: Paying off mortgage or getting the interest deduction. The other point people seem to forget about is that a mortgage payment is front-loaded with interest; a very, very small amount of mortgage payment actually goes to paying off the principal for the first 10 years. As the years go by, your interest deduction will decrease very substantially.

True. And the notion that all these people keeping their mortgages in play are investing the difference of any paydown is not backed up by any study I've seen.

People often don't invest the difference. They spend it. Or life happens and the savings are eaten up. I'm not suggesting that you become house poor - dumping all available savings on prepaying your mortgage. You want to have good cash reserves, retirement savings, college funds, etc.

Would you please help me decide which debt to pay first, my student loan or my mortgage? I have no other debt.

My $80,000 student loan is consolidated at 3.25 percent and must be paid over 30 years. My $200,000 mortgage is fixed at 5.99 percent, but I do not plan to keep my place for 30 years. I'd like to sell in five years.

I would love to get the student-loan monkey off my back, and I could in two years. Your thoughts?

Go for the student loan debt first, especially if you know you are going to sell the home in five years. By the way, I don't care if student-loan debt has no interest. It's still a noose around your neck. It limits your choices.

I'm about to take a major step in life and return to school. I've accumulated approximately $30,000 in savings over the past five years, and I'm wondering if I should use any part or all of that for tuition and living expenses or pay for that stuff with loans and hang on to my cash for something like a down payment in a few years.

Use the money for school.

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