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The myth of mortgage interest deduction

It's not nearly as good a deal as you may think.

By Karen Datko Mar 9, 2010 9:23AM
This post comes from Jim Wang at partner blog Bargaineering.
 

The mortgage interest deduction is one of the most celebrated tax deductions in all of tax deduction-dom. It’s cited as one of the benefits of homeownership, right behind “you’re not throwing your money away,” and it is repeated over and over again. Unfortunately, I believe it’s misrepresented. It’s not as good as you think.

 

I’ll explain why.

 

To claim the mortgage interest deduction, you have to itemize your deductions. For those who aren’t familiar with the idea of claiming itemized vs. standard deductions, you have two options when you file your return. You can either list all of your deductions, such as the mortgage interest deduction, or you can just claim the “standard,” which requires no proof.

The reason the deduction is a myth has to do with the size of the standard deduction, which you get even if you don’t own a home. Here are the standard deductions by filing status for 2009:

  • Single -- $5,700.
  • Married filing jointly -- $11,400.
  • Married filing separately -- $5,700.
  • Head of household -- $8,350.
  • Qualifying widow(er) -- $11,400.

I recently received my Substitute IRS Form 1098, which is a form my mortgage lender files with the IRS. The form lists, among other things, all the interest I paid toward the mortgage last year: $11,521.87.

 

If we didn’t have mortgage interest, we would claim $11,400 as our standard deduction. To claim the $11,521.87, we have to pay $11,521.87 to our mortgage company. If you assume we’re in the 25% tax bracket (2010 IRS tax brackets), here’s how we make out from a cash-flow perspective:

 

 

Married filing jointly

Single

 

Itemized

Standard

Itemized

Standard

Interest paid:

$11,521.87

$0

$11,521.87

$0

Deduction:

$11,521.87

$11,400

$11,521.87

$5,700

Tax refund:

$2,880.47

$2,850

$2,880.47

$1,425

Net cash:

-$8641.40

$2,850

-$8,641.40

$1,425

Difference:

-$11,491.40

 

-$10,066.40

 

 

"Interest paid" is how much money was spent throughout the year for each case, and in this case it's $11,521.87 for the homeowner and $0 for the renter (to use simpler terms). "Deduction" compares the mortgage interest deduction of $11,521.87 against the standard deduction of $11,400 or $5,700, depending on filing type. The "tax refund" is simply 25% of that, since we are assuming the 25% tax bracket. The net cash is to the taxpayer: Take the refund they received and subtract the interest they paid. The delta is the difference between the homeowner and the renter.

 

As you can see, in both cases, the homeowner pays more. Much more (and interest, unlike equity, isn’t something you get to keep).

 

Did you know that you can deduct real-estate taxes if you claim the standard deduction? It’s Line 7 of Form L and you can deduct up to $500 (single) or $1,000 (married filing jointly) of your real-estate taxes. This makes the mortgage interest deduction even less appealing since you can deduct part of your real-estate taxes and claim the standard deduction.

Of course, that’s not the whole picture, because there are many other factors. There are tax deductions made available to you when you itemize, such as charitable deductions. Also, when you rent, the idea of “throwing your money away” does have a bit of truth to it because you pay for a portion of the landlord's mortgage interest and property taxes without getting the deduction for it. Of course, at that point it's more a debate about the broader qualitative and quantitative aspects of the rent vs. buy question.

 

So, why do people buy homes if there's such a big difference? The difference in what homeowners pay in interest really amounts to what renters pay in housing costs. The table above omitted that because we were looking strictly at the interest deduction, not at housing costs as a whole. People buy homes because when they make a mortgage payment, part of it increases their equity in the home. When you rent, none of the payment goes toward owning more of that home or apartment. As the years pass and the principal portion of the mortgage payment increases, you get closer and closer to owning a home.

 

But when you look strictly at the mortgage interest tax deduction, it just doesn’t add up financially.

 

Thoughts?

 

Related reading at Bargaineering:

374Comments
Mar 9, 2010 9:25PM
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Throwing your money down the drain on rent is the biggest lie this country has ever brainwashed into the public.

Mortgage interest = Rent

You can always find an equivalent house that you can rent for half of what you would pay in "owning" it (mortgage).  If you are self-disciplined and save that extra money, it is ALWAYS a no-brainer that you WILL come out ahead in renting.

But that requires self-discipline, which very few of americans have.  I have been saving for the past 3 years now (no debt) and in a couple more years will buy my pick of a house outright with cash.  Tell me again, how am I missing out on appreciation when most houses are underwater right now?
Mar 9, 2010 9:17PM
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So when I'm 55 my house is paid off when I own a home.  If I rented I probably pay rent for another 30 years.  How much will that add up to?  Assume $1500 minimum x 12 months = $18,000 x 30 years = $540,000 assuming my rent never went up one penny.  Plus my kids get zero when I die.  This is and always will be a silly argument.
Mar 9, 2010 9:13PM
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For this particular scenario the argument basically breaks even. There are a number of variables which could/would make this a failed hypothesis. 1. Higher taxable income bracket. 2. Any state income tax. 3. Any charitable contributions which the writer brushes off as insignificant

So many other factors in the "rent vs. own" debate only make his scenario less beneficial over any period of time beyond a single year. I hope this guy isnt an economics or math professor somewhere.

Mar 9, 2010 9:09PM
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Cant speak for others but. In 6 years my $1500 mo mortgage will be zero.

Thats $1500 back to my budget, Plus I will always have some where to go. Unless the property taxes get to high....

I guess then I will take the standard deduction.

 

hey wait a minute!!!! people around here are paying more for rent than on a mortgage.

I see people paying more than $1500 for a shleppy apatment. Let alone a 3 br house in a good area. Must be a NewYork thing.

Mar 9, 2010 9:09PM
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MSN....Please stop posting idiotic articles like this. Home mortgage interest and property taxes are important deductions and make home ownership a good thing for Americans !  It encourages investment. Do you want a nation full of renters ????
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I agree that the article is very flawed from a cashflow perspective. The decision to rent vs. buy has many complex components. You have to account for the all in costs and then figure out what percentage of that is "thrown away" like taxes, purchase costs etc etc and also how long you will keep your home. If the only reason you buy a home is to deduct the interest then its a short sighted decision. Rent vs. buy is an individual decision and to some degree a gamble.
Mar 9, 2010 8:56PM
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Our interest in 2009 was $48,000 and the taxes were $12,000. For that $60K expense, we got $20K back on our taxes. The homeowner interest deduction makes my million dollar home much more affordable. Math doesn't work on the small side but does helps us on the high end.
Mar 9, 2010 8:53PM
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I love how all the "would be" economists are spouting their theories, which they probably heard from their favorite shock jock, about who is at fault for the housing crisis.  The idiots who got into variable rate loans that they couldn't afford and the bankers who gave them the loan.  Yes, deregulation of the glass-steagall act did amplify the crisis, but it did not cause it. 

Alan Greenspan and the Federal Reserve warned of the housing crisis as early as 2003 and everyone choose to ignore him.  The only thing the Greenspan ever said clearly during his whole time as the Fed Chairman was he was creating a bubble in the housing market to save the rest of the economy and that home values were mostly paper values not actual values.

 

The idiots who got into a variable rate loan while rates were at 40 year low thinking they wouldn't go up and the lenders who gave them the money.  That 1% of borrows flooded the market when they couldn't make payments anymore.   The Glass-Steggall Act deregulation just caused the crisis to reach more people than it would have otherwise.

Mar 9, 2010 8:52PM
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This guy is looking at the short term of renting versus buying.  Renting in the short term may be good, but where i live in honolulu, real estate prices double every 10 years. Of course rent is lower than buyings at first, but over the years the rent increases with time but your mortage payments stay the same  plus the property values increases so you can sell your home at a gain while renting you get nothing plus no tax deduction.  Looks at past data, 25 years ago what was rent and what was your mortage.  If you decided to buy you would be paying a minimal amount compared to what rent rates are now going for.

Mar 9, 2010 8:47PM
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Own vs Rent  Financially either can outdo the other, it depends on the indivudual.  I don't think I know anyone who rents and invest the difference.  Most renters spend any potential savings they may get.  Homeowners do get equity from appreciation and paydown principle.  Really it it just lifestyle.  Adults with children may want a home with a backyard and a young single may want to be downtown near bars and shopping.  Usually people rent when young and buy when baby is on the way.  Both have their purpose.
Mar 9, 2010 8:42PM
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Are You Awake - Well said.  Thank you.

 

The article was written to point out that owning a home just for the tax break is not all it's cracked up to be.  It doesn't consider all the factors and variables that one should consider when deciding to rent or buy.

Mar 9, 2010 8:37PM
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People, you're all looking at this wrong.  If buying a house is only an investment decision for you, you're buying it for the wrong reason.  Buying a house should always be, first and formost, about where you want to live, the lifestyle you lead, etc., etc.   Yes, for most of us a home has been a good "long term" investment because of the appreciation in the housing market in this country the past 50+ years.  Only recently, when home ownership became akin to "how to make a fast buck" did things go to hell!  If home ownership isn't your thing, by all means rent, but if a long-term lifestyle in a home/area you desire makes it make sense for you, buy.  One last thought,  the extra tax break available for deducting mortgage interest helps in the earlier years of your mortgage, when you likely need it the most.  When you're within 4 years of being paid off (as I am) the tax break is minimal, but my income and the equity in my home are both much greater now - the best of both worlds if you ask me!
Mar 9, 2010 8:33PM
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How about this everyone.  Buy a home if you can afford payments, want to make something your own, don't want others to enter your place when they want, don't want to have to complain about noisy neighbors above, below, behind, or next to you, and if you want the proud feeling of owning something you can all yours.  Otherwise rent.
Mar 9, 2010 8:25PM
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sarasep,

 

This is a very good point.  But, my mortgage will be paid off and you'll still be paying rent.

Mar 9, 2010 8:24PM
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#6
Tuesday, March 09, 2010 6:58:32 PM

@Tired of Bashing -

"Democrats controlled congress since 2006.  look it up, I promise its true..."

 

Uhhhhh...WRONG.  The Democrats had slim House and Senate majorities from January, 2007 until January, 2009, then they had larger majorities thereafter.  They won it in the 2006 elections, but did not realize the power until the additions were sworn to office. 

 

The Republicans controlled the presidency - a powerful one - from January, 2001 until January 2009. 

 

I cannot even remember from how far back the Republicans have controlled the Supreme Court.

 

Look it up!

 

Sorry, but the GOP owns this mess, no matter how feverishly they try to pin it on the Dems.

Mar 9, 2010 8:18PM
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It seems that maybe some folks here either don't understand what is available for rent in larger cities, or maybe, um.......I don't know......Eye-rolling

What I DO know is that in large cities, there are awesome apartments for rent of all types, and they have amenities that you can't even TOUCH when buying something comparable.

I have a pool, a gym, covered garage parking, tennis courts, a gated, secure (24-hour security guard) entrance, fireplace, huge deck, laundry service, dry cleaners, a huge clubhouse for parties, plus an available-per-night 2-bedroom fully furnished unit for whenever family/friends come to visit.......and when anything breaks, I am responded to, and problem is FIXED, within 24 hours. I can also paint, hang light fixtures, AND put on custom shower heads, faucets, etc., anytime I want. I have been a property 'owner' for many years in the past, and I can personally assure you all that owning a property versus renting is simply a matter of personal preference. You can run the numbers all day long, and spend your evenings doing spreadsheets (instead of out living your life), but I can save you the trouble - owning is usually MUCH more of a HASSLE than renting - but of course, it all DEPENDS on WHERE you live, and what TYPE of property you own, plus your lifestyle - just like anything else. So all you folks who are black and white - right and wrong -one way or the other.....get a clue!! It is whatever works for YOU and your situation - stop telling everyone else that there is only ONE 'right' way to live!!

Oh, and one more thing.......for those of you who are always whining that 'rent always goes up' (and of course, property taxes do, too).......I recently checked on this just out of curiousity - and the apartment I rented approximately 14 years ago has gone up a whopping $20 per month for a one-bedroom! And no, it wasn't in a slum, AND I live in a very large metropolitan city! So it all depends on WHERE YOU LIVE! Wake up, people!

Mar 9, 2010 8:15PM
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I find it very hard to believe that people who own a home have only the mortgage interest to deduct . . . . . . . . Believe me, if you own a home you'll have plenty to itemize including those high property taxes.  Find a good CPA and get some good advice on how to file.  It will be worth every penny.

Mar 9, 2010 8:13PM
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#2
Tuesday, March 09, 2010 7:02:52 PM
"in 15 years my mortgage payment will be $0. how about your rent? I am sure it will  double.?"
 
And over the next 15 years you will have spent how much money on upkeep? 
 
You will have labored how many hours for maintenance,  labor that can be quantified as potential income lost?
 
You will have contaminated your body with how much in painting fumes, silicone caulking, tile grout and so forth?  the resulting medical bills in your deteriorating health will cost how much?
 
And your real estate taxes, home insurance and possibly homeowners' dues will be how much?
 
There are different ways to look at it and the values of both sides.  Why act like you have the one, correct answer?
Mar 9, 2010 8:12PM
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I love Chris' commentary and think we will all be better off when once again, long term mortgages are gone. Long term mortgages are financial vehicles for note holders to make money with their money. I wonder if most people realize that it wasn't that long ago that you paid cash for your house and property for the most part. If you had incoming producing property you might get a loan but long term loans not likely.

 

Imagine what home prices would be like if the longest term loan you could get was 5 or 7 years? and the risk profile would certainly much better for the lender and the home owner.

 

20, 30, 40 year mortgages are nothing more than rent (and as the author and other comments have pointed out, in certain circumstnaces they can be more costly than rent). They can only be considered investments if the price appreciates rapidly and I think those days are gone for a long time.

 

Mar 9, 2010 8:05PM
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BY GOP2004:

"If a prospective homeowner chooses to look at all factors, like mortgage interest deductions, property tax deductions, potential appreciation, building wealth thru equity, quality of life and all the other things that come into play when considering home ownership then the decision comes down on the side of buying a suitable and affordable home probably 3 times out of 4. If you are not one of the 3 you have some kind of unusual life situation. Thats not a value judgement, its just a fact."

 

No, it is an opinion.  As I stated in my example, I would today probably have been a semi-retired millionaire by now if I had rented and wisely invested, instead of starting at square one.

 

Unlike five years ago, most financial planners, r/e agents and even hard-headed accountants have come to realize that buying a home is not the best financial investment, not by a long-shot.  It is not liquid, and therefore you get stuck when you most need to liquidate the investment.  It is a rare stock that completely vanishes when things get tough.  Not so with a house. Not just for me, but a bunch of other people whom I know of that have lost their homes, are in the process of losing their homes, or are likely to lose their homes within the next two years (thanks to the GOP of 2004...and 2000...and, well, you get the idea).  And these are not in Nevada, Michigan and Florida. It's even worse in places like those.

 

Those are complete, absolute investment losses - FACTS, my friend.   And for people that have full-recourse mortgage loans, the misery continues in the form of lawsuits, judgments and seemingly endless collection calls, after the house is long gone.

 

If you do not know a lot about investing nor financial planning, then homeownership is a simple way to invest.  Maybe that simplicity suits you.  I am one of those guys who knows how to invest...when I have the disposable money with which to do it. Homeownership does not suit me. Don't talk to me about opinions being facts.  That type of thinking got us all into this mess to begin.

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