Question about tax benefits of paying interest on a silent 2nd mortgage?

Question

When I bought my home I took advantage of a first time homebuyer's program. Part of the deal was a silent (no payments to be made until end of loan) 2nd mortgage for $25,000 at 5%. Another silent 3rd mortgage of $10,500 at 3% was part of the deal.

So here's my question. I've been paying the accumulated interest every year on the 5% silent mortgage, because I get an immediate tax deduction, and it's essentially the same as investing that money at 5% with no tax due later.

But what about the 3% loan? Is it financially a wise decision to pay the interest down on that one too? Yes, I get an immediate tax deduction, but from then on it's like investing at 3%, which I can do much better then even in an online savings account

I realize that I am actually paying interest. However it is an investment over the long run, after I sell my home. I will save owing 5% on the balance I've paid, and that equity will be there tax free when the home is sold.

Answer 1

It depends on your income tax bracket and the opportunities available to you for investment. Let's assume your income tax bracket is 33%. Let's also assume the interest on the third mortgage is $300 per year. If you pay the interest on the mortgage, that costs you $200 after taxes since you would save 33% in taxes. You will a aviod future interest of about $9 dollars per year by making the $300 interest payment early. That is a return of 4.5% per year on the $200 net that you invested. If you have opportunities to earn more than 4.5% or more per year on your money, you should not pay the interest early. If not, then pay the interest early.

Jim Kirby, CPA

Answer 2

you got it all mixed up - paying 5% interest is the complete opposite of making 5% interest. If you are in the 20% tax bracket, the 5% interest loan is really costing you 4% because you get a 20% tax deduction on the interest 20% x 5% = 1%
It is still costing you 4% - you aren't making 4% - if you start the beginning of a year with $100 and it's invested at 5% - you have 105 at the end of the year . If you have a $100 mortgage at 5% - you have spent (after tax benefit $4.00 by the end of the year . minus $4 is not equal to plus $5 - BIG DIFFERENCE.

Paying a 3% mortgage is NOTHING LIKE Investing at 3% - they are total opposites

Answer 3

Everyone says pay off the mortgage. I say it depends on what you can do with the money if you invest it. If you are only paying 6% interest and after taxes it's more like 4.5%; that's just a little higher than inflation. If you believe you can earn more (after taxes of course) investing that money, you are better off NOT paying off the mortgage. It's always nice to own your home free and clear but you need to figure out if you are better off investing the money. You can always pay it off in the future. Some really conservative investments pay more than your after-tax interest costs.

Answer 4

A $10,500 mortgage at 3% amounts to interest of $315 a year. This is nothing to quibble over. I would probably pay it and keep current, why not.

As far as your tax-free capital gains when you sell your home, that is in no way related to the balance on your mortgage or your interest rate, so separate that out from your thinking.

Answer 5

If you have options, pay the one with the highest interest rate. If you can make more money by saving rather than paying the best course of action should be obvious.