A friend just sent me a video clip. It showed an ice fisherman sitting alone on the lake with a pole in his hand. In the background, you could hear the wind whistling over the frozen lake. The pole dipped a few times as the man began to reel in a fish. Suddenly, a huge shark broke the surface and ate the man. Naturally I was caught unawares and surprised by the shark. It was funny.

But sometimes our finances work the same way. We think that we're fishing for something small. Even think that we've got it hooked. Only the truth is that we're about to be swallowed by something much bigger than we are.

I wonder if that's not true with some folks who took out mortgages with low teaser rates that were to be adjusted in a few years. They thought that they were just getting a good low rate on their mortgage and that they had found a way to buy a home that they couldn't really afford. Unfortunately, now that the rate is about to be adjusted, some of them will be swallowed up and lose their home and credit rating.

Some surprises can't be predicted. Our ice fisherman's encounter with the shark for instance. But some, like the mortgages with sharply escalating rates, can be predicted. And, unless you like being eaten, it's probably wise not to go fishing in that pond. It's too late for some people now. Hopefully, others can learn from their mistakes.

I'm 35 years old and have the option to pay off my mortgage and be totally debt free. After paying off my mortgage, I'd still have approximately $68,000 to invest for retirement. I'm really confused about whether it will be best for me to pay off my mortgage or invest all of the extra money ($98,000) instead. My financial advisor and professor from a Personal Finance class I just completed are telling me it's not in my best interest to pay off my mortgage because I will no longer have the tax benefits. Some financial experts say you should pay off your mortgage as soon as possible. I'd really like to hear your opinion on this subject. -- Julie M.

Good question! And, a common one, too. When you have some extra money, is it wise to pay down the mortgage or is an investment a better choice? Let's begin by understanding the mortgage interest deduction and then work on a framework for comparing options.

Interest paid on a mortgage for your home is generally deductible on your federal income taxes. To use the mortgage deduction, you must file an itemized 1040, be legally liable for the loan, and the debt must be "secured" by the home.

The IRS defines home mortgage interest this way in publication 936: "any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan."

There are some limits to the mortgage deduction. We won't get into the formula here, but in most cases, it won't be a problem as long as the money borrowed was used to buy or improve your home.

The biggest problem with the mortgage deduction is that many people use the standard deduction. In 2004, it was $4,850 if you were single or married filing separately. Filing married on a joint return? You got $9,700.

The rules for what's eligible for deductions are beyond the scope of this article. The safest way to figure out your status is to see what you did on last year's and expect to do on next year's tax returns. The biggest items are typically state/local income taxes, property taxes, medical costs and charitable contributions. Before making any decision, see how your specific tax situation would play out.

One way to look at the mortgage interest deduction is that you're paying someone $1 in interest to get 25 cents back in tax savings. That's what would happen if Julie were in the 25% tax bracket. I suspect that most of us would be willing to give Julie a quarter for every dollar that she gave us. The point is that the interest deduction by itself probably isn't a good reason to have a home mortgage.

Now for Julie's choice. Can she get a better return by putting $30,000 into paying off her mortgage or by investing it for her retirement? We'll need to do a little math so hang on tight! And, we're going to simplify just a little. But, that's ok. This decision doesn't require three decimal places.

What does Julie's mortgage really cost her? If her mortgage were 6% and her tax rate were 25%, she'd pay $1,800 interest during the year (.06 x $30,000). But, that $1,800 in interest would be worth $450 reduction in taxes if she itemized ($1,800 x .25 tax rate). So the true cost of borrowing the money is really $1,350 ($1,800 - $450). That works out to an interest rate of 4.5% ($1,350 / $30,000).

Everybody still with me? Ok, next Julie can calculate what she'd earn by investing the money elsewhere. If Julie were to invest the money, she'd earn the investment return minus the tax rate.

Julie could invest in a lot of different things. And, they have different potential rates of risk and return. We won't get into that today. Let's simply assume that Julie found an investment that she thinks will earn 7%. In the first year, she'd earn 7% minus the amount paid in taxes. So she'd see $2,100 ($30,000 x .07) minus $525 ($2,100 x .25) or $1,575. Or a rate of 5.25% ($1,575 / $30,000).

In this particular case, Julie mentions investing for her retirement. If she's able to use a tax-sheltered account, it's possible that she won't have to pay taxes on the investment earnings for years.

So given these assumptions, the investment looks better. Remember though that predicting future investment returns, tax rates and the ability to use mortgage interest deductibility aren't precise.

Julie also needs to be aware of any biases that her investment advisers have. We're not saying anyone is dishonest, but it is easier for mortgage and investment advisers to see the benefits of taking out a mortgage and investing the money in other places. Julie shouldn't ignore what they say, but she should be aware of the context of the advice.

Finally, there's an emotional side to be considered. Some people feel more comfortable without debt. They sleep well knowing that no one can take their home. Others have a more adventuresome nature and like the thought of picking investments and earning a higher return.

If Julie takes the time to work through her choices and how she feels about them, she's likely to make a decision that she won't regret later.