The Case for Prepaying your Mortgage

Abstract

Households that already contribute sufficiently to tax-deferred retirement accounts often believe that the tax break from interest expense deduction is more beneficial than prepaying a mortgage. This idea stems from a faulty assumption regarding the appropriate opportunity cost of funds. This study covers a 26-year period and shows that prepayment is optimal for this type of household when correctly comparing the after-tax cost of the mortgage and the after-tax return of the risk-appropriate competing investment. The study illustrates that interest expense savings are greater than tax deduction benefits from 1990-2016 when prepaying 15-year and 30-year mortgages.

Keywords: Mortgage prepayment, Mortgage interest deduction, Tax expenditures

JEL Classification: G21, H24, R38