When I say the tax tail wags the dog, I’m referring to making decisions solely based on tax implications even when the decision flies in the face of good overall sense.

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I have been asked many times to give my opinion on the decision of whether it makes sense to pay off the primary residential mortgage early. These situations occur when the homeowner expects to live in the house for an extended period of time, has a high equity percentage, and has ample funds to pay it off. Most of the time, the client asking me this question doesn’t think they should pay it off. They think they “need” the tax write-off.

One day a client presented me with a situation just like that. After doing an inventory of all their assets and liabilities, they wanted my advice on how to invest their money. They had $150,000 in cash but their caveat was that they did not want to lose any of the principal of this investment. They didn’t plan on needing these funds for many years to come. With CD rates hovering under 1% at the time, they didn’t think they had any real options.

I asked them if they would like a 5% guaranteed rate of return with no risk of loss. They laughed and said, “sure, we would do that in a heartbeat.” I said, “You have a $130,000 mortgage at 5%. By using your cash money to pay off the mortgage, you could guarantee saving 5% on it, and saving money is really the same as making money.”

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They said that wouldn’t make sense because they would be losing all their write-offs. I explained that at 5%, they are paying about $6,500 per year in mortgage payments. Those mortgage interest payments, along with their other itemized deductions were barely above the Standard Deduction they can claim on their tax return. In this case, the loss of the mortgage write-off really only amounted to a couple hundred dollars. After comparing a few hundred dollars to the 5% “guaranteed” return, along with the piece-of-mind of having their residence paid off, they immediately brightened up at the prospect.

An interesting side note. They then said, “We came in asking you to invest our money, yet you told us to pay off our mortgage. How do you get paid on that advice?”

I replied, “I don’t get paid on it, but I’m a fiduciary and all I have to do is give the best answers I can to each situation.”

“That’s awesome”, is all they had to say to that.