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Ok, I know I already wrote a post about how tax deductions are a bad investment, but I think the “mortgage interest” tax deduction deserves its own hate post. Now, I know I will probably get a lot of flak on this one, but I really don’t care at this point. So here goes:
Radio Ads
Not sure if I’ve said this one before, but I ABSOLUTELY CANNOT STAND RADIO ADVERTISING!!! So, as usual, I found myself driving home and yelling at the radio because that’s what perfectly rational people do when they disagree with a piece of electronic equipment. It was an advertisement for buying some sort of custom house, and the big pitch by the radio personality was that “owning a home is better than renting because you get a TAX DEDUCTION!” I immediately told the radio host he was full of crap and DIDN’T EVEN UNDERSTAND WHAT HE WAS TALKING ABOUT! I quickly switched the station to smooth jazz and all was well with the world.
But the more I thought about the ad, the more I could not help but think that maybe that’s really one of the big reasons people justify buying a home. And don’t get me wrong, the tax deduction is a nice perk when you purchase a home, but it should not be the sole reason you decide to make the purchase. Heck, it probably shouldn’t even be in the top 5 reasons! I would even venture to say that you are better off NOT getting the tax deduction. Now, I know many of you will stop reading and jump straight to the comments, but hear me out on this one.
The Standard Deduction
Now, I have no actual evidence (not for lack of searching), but I venture to guess that many people who buy a home are married. Running under that assumption, let’s look at the tax code (oh, the joys!) to see how AMAZING this “mortgage interest’ deduction is.
To start our search, we need to know what the standard deduction is first. Why you ask? Because the mortgage interest deduction is WORTHLESS until you have eclipsed the standard deduction amount. Yes, I said worthless. Here’s how it works:
- Married Filing Jointly couples get a standard deduction of $12,200 for 2013.
- Average mortgage in U.S. in 2012 was $235,000. Interest on a 30-year mortgage at 4% would be roughly $9,325
- Your mortgage interest tax deduction did nothing.
But The “Smart” People Said It’s Better!
I know, I know. “Smart” people are going to tell you that getting a house for the tax deduction is a smart move, and will put you miles ahead of those “renter” types. And you don’t want to be a RENTER for your whole life, do you? Well, to answer that question, no, you don’t. Not because of the tax deduction, but because you can build equity in an appreciating asset. Also, because renting does kinda suck after a while 🙂
And yes, I know that with real estate taxes and other deductions you can eclipse the standard deduction and get a few extra bucks back on your taxes. But it’s not what people hype it up to be. Yes, you can lock in a super low interest rate like 4%, keep paying your mortgage at the standard rate and make more investing elsewhere. I understand that. But don’t act like you’re lowering your interest rate with the “mortgage interest deduction.” You’re not. The government’s standard deduction is free to everyone, and you’re paying a CRAPLOAD OF REAL MONEY to get your deduction. Sounds a little backwards, doesn’t it?
Comments: Did you buy your home for the “mortgage interest deduction.” Does your tax guy sell you on the benefits of having a mortgage for tax purposes? Do you hate me for pointing out that you are throwing away thousands of dollars every year and it the tax benefit is actually all smoke and mirrors?
I like owning my home because it is mine but I do look at it as an investment as well. The deductions are nice though since we do eclipse the standard deduction. We get the equity build as well as additional write off. But I do understand your argument that it should not be the reason you do it.
I love owning a home as well. But I wanted to shed light on the fact that your deduction isn’t really your whole mortgage interest, it’s just the amount that’s over the standard deduction. So most of the interest you pay during the year doesn’t actually help with taxes at all.
In Canada, we can’t write off our mortgage interest as a tax deduction. I wish we could! So of course, I don’t think anybody here would be dumb enough to buy a house for that reason, but I’m sure there are plenty of people that cite tax deduction as a good reason to buy a house if they COULD.
Yea, the tax deductions is like a big, red “ON SALE” sign that they try to use to get more people in homes. But you know, it seems to work, though it’s very misleading.
We definitely did not buy ours for the tax deduction. After we buy our next house, we definitely want to pay off the house semi quickly!
Same here. I honestly didn’t even think about it until tax time came around. It hurt more to see how much went toward interest vs the tax savings. even worse know how high the standard deduction already is!
A lot depends o how long you stay in one place. My neighbor has lived in his house more than 30 years. He also became a millionaire in the process.
He says the two are related. How can I argue with that? 🙂
Moving has serious transaction costs. Renting reduces that, so if mobility is in your future, renting is probably better.
We plan on being around for 10-15 years minimum. We love our place. And I’m definitely not saying renting is better. I just want people to know that their renting counterparts are getting a $12,200 deduction for FREE, and they are paying over $12,200 for their “itemized deduction”. Not a good trade.
Great post Jake! This one always bugs me too! It doesn’t make any mathematical sense to pay interest just to deduct a portion of the interest! Dave Ramsey says it best:
“Let’s do the math. If you have a home with a payment of $900, and the interest portion is $830 per month, you have paid around $10,000 in interest that year, which creates a tax deduction. If, instead, you have a debt-free home, you would in fact lose the tax deduction, so the myth says keep your home mortgaged because of tax advantages.
If you don’t have a $10,000 tax deduction and you’re in a 30% tax bracket, you will have to pay $3,000 in taxes on that $10,000. According to the math, we should send $10,000 in interest to the bank so we don’t have to send $3,000 in taxes to the IRS. Personally, I think I will live debt-free and not make a $10,000 trade for $3,000.”
Agreed. I touched on that a little in my “tax deductions are a bad investment” post. But it’s so true. Even worse when you think about how the standard deduction is already there for the taking!
My head wants to explode every time I read that someone thinks of their primary home as an investment.
While in your scenario the tax deduction didn’t help YET, it did get them closer to the point that they can itemize. After other deductible taxes, medical costs (long shot), charitable deductions, etc., there’s the possibility that it helped.
I agree with a recent study that showed over half of the people who bought homes in 2011 would have been better off renting. We’ve been sold a bill of goods around the fantasy of home ownership = not throwing money away.
Sure, it does help get to itemized, but with a guaranteed $12,200 already, you could spend $0 in interest/taxes/contributions and still be sittin’ pretty, with an extra $12k in your pocket.
Didn’t know about that study, but I bet the tax incentives have something to do with it!
I agree. It’s just a side benefit, but a very nice one at that!
The deduction really starts making sense for those with marginal taxes higher than 30% though. If you are in the 39.6% tax bracket… then it would be foolish not to own, even with the AMT.
Once you’re getting 30% off, the incentive is there. Just don’t count the amount up to the standard deduction because it’s already free from the government. But if you are raking in the dough, and can pull in a better than 4% return, then go ahead and keep the mortgage. Just don’t think your tax deduction is going to make you rich 🙂
Maybe the question is: is there ANYTHING at all worth buying solely for the tax deduction?
I would say NO! Don’t buy something unless you need it, and then you can consider the tax implications. See my post “Tax Deductions are a Bad Investment“
I don’t have a mortgage but I just want to say I love the standard deduction! Itemizing seems like a bad deal – lots of work and it generally means you’re spending money on something you shouldn’t be (except for charitable giving).
Yes! Exactly!
Oh I completely agree. Buying for a tax deduction is silly. The standard deduction will keep increasing with inflation (hopefully) and the interest you’re paying will decrease as you pay your mortgage down. So the bar to itemize keeps getting harder and harder to reach.
Personally I love the fact that we can’t itemize. We get more of a deduction just using standard than if everyone had to itemize.
Not itemizing through interest and tax expenses is one of my goals. Itemizing solely through charitable giving is another one of my goals 🙂
Yes! In most cases, buying a home is cheaper than renting the same home, and you get ownership, which is the best reason for buying. But spending money to get a discount (effectively) really makes no sense, especially when the discount isn’t very good.
Exactly. Buy a home for the right (financial) reasons, not the wrong ones 🙂
My best friend has always said do it for the tax deduction, but that never made sense to me.
With a low mortgage I am paying less than rent in my area so maybe when you figure that in it makes more sense.
Well, low mortgage, low interest rate, good price….those are all valid reasons to buy. Interest deduction? Bad reason!
Good advice. I’d wouldn’t buy anything solely for the tax deduction. If we don’t need or want something, the deduction wouldn’t be a motivating factor, since as you said, most folks don’t really save or make any money with deductions.
Yup! Agreed!
Totally agree. The tax deduction is a nice added bonus if you’re going to buy a house anyway…but it isn’t a good enough reason to buy a house! It also isn’t a good enough reason to not pay off your mortgage in my opinion.
Preach it, sista! But seriously, that commercial makes my blood boil. Once I start hearing it now, I change the station immediately so I don’t start road raging! 😉
Absolutely agreed, Jacob. Another mortgage is a huge headache and, more importantly, simply not financially smart for the sake of a tax deduction alone.
First let me say that I love your blog and I am in finance and I do budgets for a living,however, did I do a budget for my finances BIG HELLA TO THE NOOA!!!! So thanks for reminding me, if I can do it for my employers I shoudl be doing it for myself. I do agree with you. I didnt but my house for the tax deduction, I bought it because I want to paint my own walls and not still be paying rent at 65, KWIM.
I am the typical married, 1 kid and the fence american family. I live in the NE and standard of living here is pretty brutal to say the least. I lost my deduction this year because my stay at home husband to my young son joined the work force and between both our incomes, we lost pretty much every deduction on the planet. Mit pays less taxes than I do. But I think it would have been much worst, if I didnt have the house.
Nicola, thanks for checkin’ out my ridiculous blog 🙂 It’s weird, isn’t it? We can do something for a living, and be AWESOME at it, but neglect that very thing in our personal lives. Kinda like how some financial professionals COMPLETELY mismanage their personal finances, but make a KILLING at work. Great part is, you can start right now with a flippin’ sweet budget and some goals to get you where you’re going faster and with more fun involved 🙂
The first thing we did when we bought our place is jump up and down on the floors after 10pm because we could! LoL. I hear you on living costs, I’m in the NW, and we’re in an expensive area for sure. We’d have a freakin’ mansion and 5 acres anywhere else! Sounds like you guys are rocking the income, and now you just need to harness it and kick some personal financial booty. And as I tell my tax clients who phase out of all the deductions “who cares, you’re making a crap load of money!” Nice work! And thanks again for stopping by!
We came very close to eclipsing the standard deduction this year, and that’s with only owning a home for a couple months of the year. I didn’t buy it for the deduction (there was rumors of that being axed when I was looking at homes last summer), but it definitely is a small perk of owning a home (our tax code is messed up…don’t get me started….). With that being said, there are fun little things that come with buying a house like sewer drain-outs that require digging out the street to repair and being billed thousands of dollars…all unexpectedly : )
Agh! I remember that story. What ever happened with that? And yes, the deduction is nice if it kicks in, but think of it as icing on the cake, not a goal to pursue. Heck, and better goal would be to pay it down quickly and own it so you DON’T itemize 🙂
My home is my home, not an investment (even though I have made a lot of $ on it!) Also, my standard deduction is better than my mortgage interest! I love my place 🙂
Nice work on paying it down and building equity! I hope to get to the point where the standard deduction eclipses my mortgage interest!
Don’t forget this is a deduction on your taxable income, so you don’t even save the entire amount that you pay in interest. To quote Dave Ramsey, it is pretty stupid to pay $10,000 dollars in interest to the bank to save $2,500 dollars on your taxes, as you come of $7,500 dollars in the hole. If you have the money get rid of your mortgage.
Sadly in quite a few areas of life a lot of people have a habit of spending more than they would, to save money in some other area. A lot of rewards programs work in similar ways.
Yea, I think of deductions as like a sale. You get whatever percentage your effective tax rate is off your purchase. But really, the standard deduction is there for FREE, and you don’t have to waste money to get it 🙂
A house shouldn’t be purchased ‘for the tax deduction’ any more than you should donate to charity for the deduction. $1000 donated to charity still costs me $750, but the good feeling isn’t from the tax effect, it’s from choosing the worthy cause.
When it comes to buying a house, if you run all the numbers and it’s the tax deduction that somehow makes your rent vs buy decision tip towards buying, it’s too close a call. When listing out all the pros and cons for buy vs rent (people still do this, right?) I’d go so far as to say that if the tax deduction is even in your top 10 reasons to buy, you should reevaluate your plans.
Yup, agreed. the tax deduction is a small incentive to increase home ownership, but should not be the deciding factor, or even in the top 10, like you said!