Thursday, October 13, 2011

So the government wants me to borrow money, eh?

When at the financial fireside the other night (described here), the speaker, as he was a real estate man, repeated the oft-touted fact that one can write off the interest they pay on their mortgage. I chimed in (which I probably do too often), saying “only if you itemize!”, which point he quickly conceded. I probably wouldn’t have said anything if I hadn’t previously been bothered by the public’s infatuation with, and misunderstanding of, this particular government subsidy (technically a tax break, but it amounts to the same thing).

To try and be objective about it, what I’m referring to is the federal government’s home mortgage interest deduction policy. What it does is allow a person (or couple) to add mortgage interest to one’s list of itemized deductions at tax time. After calculating your adjusted gross income (AGI) each year, to arrive at the amount of your income that’s actually taxed you have a choice between subtracting either the standard deduction or a list of itemized deductions. Besides mortgage interest, things you can itemize include charitable contributions, medical expenses, some state taxes, and (interestingly) gambling losses. The rub is that the standard deduction currently is $11,600 if you’re filing your taxes jointly and $8,500 if you’re the head of household. So, in order for itemizing to be worthwhile, you likely either have to have donated a bunch of money to charity and/or be paying a significant amount of interest on your mortgage. Which brings me to my first point: not everyone with a mortgage (especially in the loan's later years) is paying $11,600 a year in interest and these people subsequently won’t get a special tax break.

The second important thing to remember is the fact that, since everyone can claim the standard deduction, the mortgage interest tax benefit only kicks in on the amount of interest you're paying above and beyond $11,600 (if filing jointly). Soo, if you’re paying, say $15,000 in interest per year, you’d get the special tax break on only $3,400 of that amount. If you’re in the 25% tax bracket, that’d save you $850 per year. It seems low, right? But, remember it’s a tax deduction and not a credit. And that’s a lot of interest to be paying. Plugging some numbers into this calculator (be sure to hit ‘show amortization table’), it seems that a ~typical home in America wouldn’t cost one enough interest to get much above the standard deduction (unless one had other items to write off). For example, a loan value of $200k with a term of 30 years and a 5% interest rate leads to a payment of $9933 in interest in the first year (which is lower than the standard deduction, if filing jointly). And the yearly interest paid only decreases from there. It seems that one would have to have a large mortgage (or lots of other things to itemize) to benefit much from the interest deduction, which is why most economists oppose the subsidy. Considering what’s happened to the country the last few years in terms of over-leveraged consumers, perhaps the government shouldn’t be encouraging people to buy so much home, or any at all. What am I missing?

With that, I'll be in southern Utah for a few days for fall break and Bags will have to keep you entertained. Stay safe.


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  2. Levi, This is exactly what I had been saying leading up to the time before we bought our home. We saved until we had 20% down, and people thought I was nuts (We also had some inheritance, as my fantastic meteorologist salary would not have permitted such savings). But people and realtors and friends kept referencing the mortgage interest write-off (while encouraging us to buy), and I just didn't understand why people were so juiced about writing interest off. I eventually bought a house for $215K at 5.0% and have recently re-financed down to 4%, so NO, the interest is NOT enough to itemize to my advantage. (Just like I knew it would NOT be). LOL. In fact, I had the smallest tax return of my life AFTER I bought my house! Now, I did buy a foreclosure with a low-ball offer, and I was able to refinance even 2 years after purchasing it because we have been fortunate enough to maintain at least an 80-20 loan to value, but all in all, I don't know if I'd do it again. But my wife and kids were tired of our apartment, and my mortgage is less than I would pay in rent. But still......

  3. By the way, I enjoy reading your blog. Nice work!

  4. Thanks, War. I love that people thought you were nuts for putting 20% down. Hilarious. Sounds like you did it right. Makes it nice being able to refinance, whereas most people wouldn't have gotten the chance (and maybe were even underwater). Stuff for future posts, for sure.