I’m going to make a statement that is bound to divide you, dear readers, into two camps: the “Are you crazy?” folks and the “Right on, (wo)man!” people.
Are you ready?
I think the mortgage interest tax deduction is a joke, and I’d rather not claim it on my taxes.
Whew. Glad I got that off my chest.
My Rationale
Yes, we chose to buy a home. We know that our 5% mortgage, while at a decent interest rate, is going to have us paying $268,000 in interest over the 30-year term of the loan. That’s only $20K shy of the amount of the loan. And I think that’s sickening.
As a loan amortization table demonstrates, you’re paying the bulk of your interest in the beginning of the loan period. So our $1,550 mortgage payment is made up of $1,200 in interest. Sure, at the end of the year, that’s a lot of $$$ to deduct if you itemize your mortgage interest. But think about what you could do with all that money if it were available for investment purposes. Right now, it’s just money being paid to the bank, and for every $1 of that, you might get 35 cents back in a tax refund.
For our example, $1,200 in interest over 12 months is $14,440. The standard deduction for married filing jointly (that’s me and Mr. Saver) is $11,400. Sure, it’s $3,000 more to itemize the interest, but what we’ll get back from that is just another $1,000 or so.
I don’t think it’s worth paying the bank just to get some cash back from the government. I’m a strong advocate of paying toward your mortgage principal and knocking down the amount of interest that the bank is getting. The lower the principal amount, the less you’ll be paying in interest.
I’ve broken down how just small monthly extra principal payments or yearly lump-sum payments can shorten our 30-year mortgage anywhere from 2 to 10 years, saving up to $50,000 in interest. That’s nothing to sneeze at.
It may not be a fully sustainable plan — I’m sure if and when kids come into the picture, it will cause us to reassess where our money goes — but the beauty of it is that we can choose how and when we want to make those extra payments.
If our extra payments knock down the amount of interest we can claim on my taxes next year, so be it. I’ll be laughing my way to the bank with the money we’ll have saved down the line. And knowing our home will be paid off before our retirement will be an added bonus.
FDIC Chairwoman Questions the Deduction
What’s even more interesting is that Foxbusiness.com is reporting that FDIC Chairwoman Shelia Bair has gone so far as to cite the mortgage interest tax deduction as one of the causes of the current banking crisis. Of the federal tax and credit subsidies, Bair said, “We must avoid policies that encourage such economic distortions.”
So do the tax deductions and the First Time Homebuyer’s Credit push more Americans into buying homes that they can’t afford, all while causing the values to drop? I have to agree with this thinking — to a point. Sure, getting back $8,000 for purchasing your first home is pushing some buyers into homes before they’re ready, but shouldn’t the banks also be held responsible for subprime lending practices?
How about the existence of mortgages themselves? They inflate home prices as well. If we eliminate mortgages and pay cash for homes then home prices will plummet. Its the availability of cash, via mortgages, that raises home prices.
I don’t think you should buy a home for the deduction and paying into principle can save you thousands or more. But having the tax deduction there is a nice bonus. The idea, so I understand, is to help encourage people into buying homes.
Here’s a case where the more you make, the more you save! The tax rate you pay on your highest dollar really starts making a difference after a certain amount.
Just think of your payments in cash flow terms and not total costs if it makes you feel better. You have to pay someone whether you own the place or rent.
@DanT: I’m aware of the point — even wrote a post about that position on mortgage payoff — but again, it’s only a POSSIBILITY that you can make that money back. My mortgage rate is 5%. It would take an average return of 8% on $200 invested monthly for the next 30 years to just BREAK EVEN on the mortgage interest payments made throughout that time. It’s a crapshoot either way!
You’re all forgetting one crucial point.
If you invest the additional money that you would put towards the extra principal, it will (hopefully) grow. If, over the 30-year term of the loan, it grows at (roughly) a rate greater than your mortgage, then that money will be MORE than the money you saved by prepaying the mortgage.
So for example, and these are entirely made up numbers, if you put $200 extra per month and that saves you $100,000 over the life of the loan, you could invest that $200 per month and end up with $120,000 or $150,000 etc.
There are plenty of calculators online where you can plug your real numbers in and see exactly what the difference will be after 30 years.
I understand those people who are leery of investing in the stock market and prefer the “safety” of paying off the mortgage early, but financially it actually ends up costing for that feeling of safety.
@Mr. Credit Card: Thanks for the textbook explanation. Sure, it looks good in a short-term view, but it’s not something I think should have been sustained for this long. It’s probably artificially pumping up housing prices, too.
I concur – the less deduction, the less distortions. I studied in economic class that in theory, a firm should be indifferent between equity and debt. But because of the interest deduction, it artificially lowers the cost of debt and companies find that it is "optimal" to have some debt! Once again, encouraging debt and distorting the economic world!
Yep, I'm in the 'expensive' portion of the state (northeast).
I didn't realize you were in NJ..I share your pain then haha. The only places without ridiculous property taxes are either way south or way west,
When you add up state income tax, property tax, local tax, and all of the other deductions the home interest deduction is icing on the cake. In my eyes it effectively reduces your interest rate 25 percent. I will take 25 percent any day.
@Saving Money Today: Oh yeah, NJ here, too. Our taxes will put us over the standard deduction next year (we only had half of a year of home ownership to use this year).
@Ally: You're only counting the money — not the interest on that money. The more money you finance, the more you pay in interest. So a $200K house: You only put $10K down, you're paying interest on $190K. If you put $30K down, you're now paying interest on "just" $170K. Use a mortgage calculator that has an amortization chart — it shows you that even though your mortgage may be $1000, something like $800 of that is JUST INTEREST in the beginning! It only evens out to $500 interest/$500 toward principal halfway through a 30-year mortgage.
I have to say the worst is not having enough to put down. If we do 3.5% (trust me, at the rate we're going, we're renting forever since I can't seem to find a ft job still!) we will be paying an additional $110 (or so) per month for FIFTEEN years. We figure that's not that bad since we don't have $15K upfront to add to our down payment it sort of works the same way. Right? Probably not — all of these numbers hurt my head.
Tales Of A Fourth Grade Nothing
Between mortgage interest and crazy New Jersey property taxes my deductions are way above the standard deduction, but I do agree with paying extra toward the principal if you can afford to do it. Even small extra payments add up over the course of the loan.
@ctreit: Could you point me to a website that explains this idea further?
@SAHM CFO: I know, I can rail against it, but I'll still be claiming it on my taxes when applicable. feel like too many people use the deduction to justify their home purchases.
@Money Honey SF: Of course, not everyone can make extra principal payments (although a few of you are already doing it!), but just to play devil's advocate, if you need 'help' paying interest, perhaps you shouldn't have bought the home to begin with and/or put down a bigger down payment?
@fallingintofavor: No one should buy a house just to get $8K (or less) back from the government. That's crazy talk. But I applaud you for taking the incentive to pay extra each month. We're going to finish paying off our CC debt and move ahead with increasing our own extra principal payments.
@Little House: They're sickening, is right! Interesting idea about putting that money back in our pockets. Now that I think about it, the government is subsidizing the banks through homeowners, in a roundabout way.
The amortization tables just make me sick! Whether I look at them to see how much interest I will eventually pay on a mortgage, or if I look at them on my line of credit I'm still paying off, it makes me want to puke! The money in your pocket from your deductions would be more beneficial if it was in your pocket to begin with. Too bad they can't just factor that into the loan.
Good post. We bought a house last year, but not for the tax credit. We got married last year, had money saved for the purposes for buying a house and all. I do know of other couples trying to buy a house JUST to get the tax credit since it's been extended.
We currently pay $100 extra a month toward our principal and will likely increase it sometime this year.
Very good post. But are you missing the point that not everyone is able to make extra principal payments to reduce the interest paid on the mortgage.
And because of that, the tax deduction on interest is to help those that can get some money back from paying so much interest.
Either way, this is an excellent post. We are paying an extra $200 towards our principal too. It goes a long way in shaving off the total interest that will be paid over the life of the loan.
It's almost the same as someone paying the minimum amount on their credit card payment.
It is strange that the government is incentivizing debt. The bigger the mortgage debt the bigger the tax deduction too!
Of course I'd prefer NOT to have a mortgage but if they are handing out money for debt I'll take it:)
I guess the mortgage deduction only makes sense if it compares well with renting, since you need to spend money on housing one way or another. So, the $1200 are not completely "lost". You have to compare the $1200 (after tax) with the price of renting a home to determine which one makes more sense. Well, you need to factor in a few more things like how long you plan to stay in the area, etc.
@JoeTaxpayer: In my roundabout way, yes, that's exactly what I mean. I will claim it because it would be silly not to — but I'd rather save on the interest end.
Hmmm. I'd rather not have the interest either. Of course, I'll fill out my tax forms to minimize my taxes, I don't think you are saying you 'won't' take it, just that you'd prefer not to pay interest in the first place. Agreed. 100%.
@Executioner: Had a feeling you'd be on my side on this one.
@EOW: You make a good point — I was only focused on the mortgage interest deduction. We can deduct our property taxes, too, but have no children, so no additional exemptions. But I'd still rather see that money stay in my pocket to begin with!
I understand your rationale and I do agree with you to a point. The big thing that jumped out with me is your example of paying $1,200 interest and it's just a bit more than the standard deduction, might you have other deductions as well?
As for the interest, I get that. For me personally, I love the ability to have access to $200, $300, $400,000 of other people's money. I'll take than any and every time and make sure to use it properly.
Couldn't agree more. I also think the tax exemptions for children are a mistake, for similar reasons.
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