Refiance my mortage or not?

Question

I have a substantial amount of $$ from an inheritance. I want to put a chunk of it towards my mortgage and reduce my monthly payment and not pay the bank so much interest. My wife thinks that we should not do this as we benefit from the interest on our taxes. I think for every dollar of interest we pay we only get 30 cents for a tax benefit. Who is correct?.

Answer 1

You are correct in that the tax benefit from the mortgage interest deduction is overrated. However, if you have an existing mortgage and pay a lump sum on it, your monthly payments do not decrease. What happens is that a larger portion of your payment goes toward principal. Your payments stay the same unless you re-amortize or refinance the house, which has additional costs.

So keep that in mind when you decide how much to pay down your mortgage.

Answer 2

You'd have to look at the interest rate on your mortgage (minus the tax benefit) compared to the income you'd get from whatever alternate use you'd make of the money (adding any taxes you'd owe) to decide that. It can get pretty complicated, and obviously requires some guessing on the income from the alternate investment. But if your mortgage rate is high (or adjustable) it would probably be good to put the money toward the mortgage: if the rate is low, might be as well to put it elsewhere - you could use some of it each month to help out with the mortgage payment.

You wouldn't have to refinance though to pay extra - almost all mortgages allow you to pay extra, thereby cutting down the length of time on the mortgage since it would go toward principal. But if you want your payments reduced, then yes you'd have to refinance. When making your decision, take into account any refinance costs - there will probably be some.

Answer 3

If you can get a higher rate of return on investing the money than the interest rate on your mortgate, keep the mortgage and invest the money.

If not, pay down the mortgage as you only get limited benefit from the mortgage interest deduction. It's worth less than 30 cents on the dollar for most taxpayers. To figure the real benefit of the deduction, only consider the portion that exceeds your standard deduction amount and apply your marginal tax rate to that amount. I was shocked to see how little mine was REALLY worth.

Answer 4

You are correct in assuming that the tax savings is low. If you calculate your taxes for the year both ways, you will find that the interest you pay costs you much more than the tax savings. An example: $200,000 mortgage at 10% , payment 2,000.00 per month equals roughly $17,000 interest for one year. Tax write off $17,000.00 with an average taxable amount of 30% equals $5,100 in total tax savings, so you lost 17 thousand dollars to save 5,100.00 not a good plan. On the other side, if you reduce your mortgage by oh, say $75,000.00, your payment would go down by roughly $750.00 per month using the same rates in the previous example, and thusly the interest paid would go down to roughly $12,000...so, not only do you save the $750.00 per month, but you would also save $5,000.00 in interest which is totally non-recoverable expense. Start to make sense? To recap: if you save $5,000.00 in interest, $750.00 on the actual payment, and refinance at a lower rate, you in essence gave yourself a $14,000.00 raise EACH YEAR! Not to mention the additional savings from re-financing at a lower rate! Plus, the tax is already paid if you tax plan correctly. Now, to gain the same raise through other investments, you would have to put your same $75,000.00 in to something that would return you almost 20% per year, which although not impossible, is difficult for most. Now of course, you can use lower numbers if you like, as if you only put $40,000 toward it the numbers will be lower, but using your interest as a deduction is the worst way to use your money, because you are literally giving away thousands to get 30% Put the money in your biggest, best, most stable, most apt to appreciate investment, your house. Any other use will not reap the returns, unless you have a business idea or a second property to think about. "The best two investments on the entire planet? Dirt (property) and Water (drinking, irrigation etc.)".

Answer 5

Assume for the moment you are in the 35% tax bracket. That is currently the highest Federal tax bracket. For every $10,000 you pay in interest, you 'save' up to $3,500 in taxes. If you want to spend $10,000 to save $3,500 in taxes, donations to charity work just as well and you are not penalized if you miss a payment. If I were in your shoes, I would pay off the mortgage if possible and put the payments toward having money.

Note: ATM and lack of other itemized deduction may reduce you actual value of the interest deduction below the percentage indicated by your tax rate. The figures above are the MAXIMUM benefit.

Answer 6

You are correct.

You never want to pay interest just to get the tax deduction.