Paying down your mortgage is more attractive when its after-tax cost exceeds the return you can earn at an acceptable risk and you will still have enough cash left.
- Keeping the cash can make more sense when the mortgage rate is low or you need flexibility for a move, repairs, or uneven income.
- Compare after-tax dollars first, then decide what access to the money is worth to you.
Compare after-tax amounts
| Use of $100,000 | First-year effect |
|---|---|
| Pay down the mortgage | $3,000 less interest |
| Keep it at 4% | $4,000 before tax |
| Tax on savings interest | −$1,400 |
| Savings interest after tax | $2,600 |
Paying down the mortgage comes out about $400 ahead for the year. The higher advertised savings rate loses its advantage after tax. Keeping access to $100,000 may still be worth that $400 difference.
You can also work backward. With a 35% tax rate on savings interest, the savings account would need to yield about 4.62% before tax to match the 3% interest avoided: 3% ÷ (1 − 35%). That assumes the mortgage interest creates no additional deduction.
How much does the mortgage deduction help?
Count only the deduction that reduces your tax.
- If you take the standard deduction, paying mortgage interest may provide no additional tax benefit.
- Even if you itemize, the benefit depends on deduction limits and how far your itemized deductions exceed the standard deduction.
The IRS mortgage-interest guide explains the limits. Many loans incurred after December 15, 2017 are subject to a combined $750,000 acquisition-debt limit, or $375,000 for married filing separately. Older qualifying debt and refinancing can follow different rules.
What will the cash need to do?
Before making a large payment, give the cash a job. Keep the money needed for these jobs accessible:
- Emergency reserves
- Known tax bills
- Repairs
- A possible move
- Any period when income could stop
Paying principal moves money into home equity. Retrieving it generally requires selling the home or qualifying for new borrowing. A credit line can help, but its availability and rate can change; it is not the same as cash already in your account.
Prepayment, recasting, and refinancing are different
| Action | What changes | What to check |
|---|---|---|
| Extra principal | Lower balance and interest; often shorter payoff | Servicer handling, prepayment penalty |
| Recast | Lower payment after a lump sum | Eligibility, minimum, fees |
| Refinance | Replaces the mortgage | Rate, closing costs, term, break-even |
Check the agreement for a prepayment penalty too, especially before a large lump-sum payment.
For a refinance, compare both the payment and the payoff date. A lower payment from restarting a 30-year term can come with more years of interest.
Make the decision with four numbers
Write down:
- Cash to keep: money for emergencies and known near-term expenses.
- Interest avoided: the benefit of the proposed principal payment, after any tax deduction you would lose.
- Alternative return: what the same money might earn after tax, with its risk made explicit.
- Required monthly payment: what you still owe after the proposed change.
The objective is a mortgage decision that fits the household’s finances, not winning a rate comparison by a fraction of a percent.
