A lot of people hang onto their mortgage because they think it saves them a ton in taxes. Let’s clear that up.
The Mortgage Interest Deduction: Not What It Used to Be
Yes, mortgage interest is deductible. But here’s the catch: you only get that deduction if you itemize your taxes. And the number of people itemizing has changed dramatically in the past 10 years.
In 2017, the standard deduction for married couples was only $12,700. In 2018 it jumped up to $24,000. And with the passage of the One Big Beautiful Bill Act (OBBBA) the 2025 standard deduction has risen to $31,500. As the standard deduction rises, fewer people itemize. Unless your mortgage interest, plus state taxes and charitable donations, add up to more than that number, the interest deduction isn’t doing you a bit of good for Federal tax purposes.
You won’t pay extra taxes because your house is paid off. You just stop deducting interest you’re no longer paying. It’s not a penalty. It’s just the flip side of saving thousands in interest every year.
So don’t assume that you need the mortgage just for the tax break, run the numbers. You might be better off without it.
How to calculate the real tax savings
Let’s say you’re paying $12,000 a year in mortgage interest. That might sound like a big deduction, but in reality, most of that “deductible” mortgage interest may not be helping you. To find out your real savings, start by looking at your total itemized deductions, and subtract the standard deduction from them. If the difference is less than the amount of mortgage interest you pay, then not all your mortgage interest is really helping you. Only that excess of itemized deductions over standard deduction (the number you calculated above) is actually generating any federal tax savings. Multiply the lesser of the excess itemized deduction or the mortgage interest you paid by your marginal tax rate (compare this chart to your taxable income to find your marginal tax rate) to calculate the savings. For many states, if you aren’t itemizing for Federal, then there is no state tax break on mortgage interest either. However, for Alabama residents, most taxpayers will save 5% of the amount of interest they paid regardless of whether they itemize on their federal tax return. The main exception to that would be for retirees who have mostly pension and Social Security Income that is not subject to Alabama tax anyway.
Don’t Trigger a Tax Bill to Avoid a Mortgage Bill
One big mistake? Pulling money from your 401(k) to pay off the mortgage.
Here’s the issue: 401(k) withdrawals count as taxable income. If you pull out $200,000 to pay off your house, that’s $200K added to your taxable income for the year. It can bump you into a higher tax bracket and trigger a massive tax bill.
If you’re under 59½, you’ll also pay a 10% early withdrawal penalty on top of the income taxes. That could mean giving up 30-40% of your withdrawal just to the IRS and state.
Even if you’re over 59½ and avoid the penalty, you’re still taking a huge taxable hit all at once. That’s not a smart trade just to kill a mortgage payment.
Factors to Consider
Before you pay off your mortgage, think about your current interest rate. You would be less motivated to pay off a 3% mortgage that would make lots of people wish for the good old days, than a 7% mortgage where interest is eating up most of the payment. You can also compare this to the rate of return you are getting on the investments you might liquidate to pay it off. If you can liquidate CD’s that are paying less than 3% to pay off a higher rate, mortgage, that could be a win/win. If you are liquidating a portfolio that averages 8%, your mortgage rate is probably lower. But you might still want to cash out now so that you don’t have to worry about a drop in the stock market. From a tax perspective remember that interest income always hurts you for tax purposes more than interest deductions help you. That’s because interest income raises your AGI, but interest deductions don’t often lower it. And secondly, it’s because the interest expense may only be partially deductible.
Remember, that paying off debt reduces your liquidity, and you don’t want to get caught off guard by an emergency with no cash reserves. So for most people, it’s better to hang on to your emergency fund than to use your last dollar of savings to pay off your debts.
Summary Pros and Cons to Consider
Pros of Paying Off Your Mortgage:
- More monthly cash flow: No more monthly payment. That’s money back in your pocket every month.
- Risk Free Return: It can be helpful to think about paying off your home as an investment. You will get a guaranteed rate of return, but you can’t easily convert that investment back to cash.
- Peace of mind: Owning your home outright can be a big psychological win.
- Flexibility: Lower living expenses give you more options—retire earlier, take time off, invest in your business, etc.
Cons of Paying It Off:
- Liquidity: Money in your house is harder to access than money in a savings or investment account.
- Opportunity cost: If your mortgage rate is low, you might earn more by investing elsewhere.
- No more interest deduction: But as we covered, that may not be worth much anyway.
Bottom Line
If you’re thinking about paying off your mortgage, don’t let the tax deduction be the thing that stops you. For most people, it’s not saving as much as they think.