Owning a house is a huge commitment and a complicated financial investment. After you've signed the papers, the gravity of the commitment can suddenly hit you when you realize that you'll be paying off this house for the next three decades. For fear of being in debt for that long, many homeowners wonder if they should be devoting more money to paying down the mortgage faster. However, when tax time comes around, they might feel that they don't want to give up the tax break they can get from their mortgage interest payment. Which is financially smarter? The answer isn't exactly clear-cut.
This is assuming, first of all, that your interest payments qualify for the deduction and that you itemize your deductions rather than taking a standard deduction. Interest payments must be for secured debt from an acquisition or equity loan, and there are also ceilings on the amount of qualifying debt for loans taken out after 1987 and rules that dictate if the particular home qualifies [source: McWhinney]. (Refer to IRS publication 936 for full details.) Also, if it saves more to take the standard deduction, then you don't need to take advantage of the mortgage interest tax break at all, and prepaying the mortgage would be more important. If you do itemize, the difference between the itemized deduction and standard deduction might not be large enough to compare to the long-term savings of prepaying your mortgage.
How much you can deduct for mortgage interest payments depends on your tax bracket. The higher tax bracket you're in, the more you'll save with the deduction. Multiply your tax bracket by your interest payment to find out how much you can deduct on your taxes. Compare this to the long-term savings of paying down your debt early. Experts say that unless you're in a very high tax bracket (35 percent), it's more advantageous to pay down the mortgage than simply hanging on to that extra money [source: Pond].
But the tax break isn't the only thing to consider when deciding whether or not to prepay a mortgage. Read on to find out.