Today we’ll tackle the grandaddy of financial fallacies – the home mortgage and the much vaunted tax benefits of the mortgage interest deduction.
Start talking home loans with any financial pundit and sooner or later you’ll hear mention of the notion that you can deduct your mortgage interest from your taxes. Writing off my interest sounds good right? Let’s take a look at the reality of realty…
The Mortgage Interest Deduction (the MID):
From financial planners to career politicians the MID is coddled as if it’s a Golden God-Child that promises vast savings on your taxes by way of deducting your interest payments. Pundits will encourage you to hold onto your mortgage for as long as possible, or encourage you to sign a 30 year mortgage in order to take advantage of MID benefits on your tax return for many joyous years to come. Some will go so far as to encourage you to reduce the equity in your home in order to increase your interest payments and your MID, all in the name of supposed tax benefits.
As a great example, I easily found a financial planner via search engine who had written an article on his website entitled “11 Great Reasons to Carry a Big, Long Mortgage.” He listed the MID as both the #4 AND #5 reasons. So in the end, I guess he really only had 10 Great Reasons – oh boy, a financial planner bad at math. Contrary to this line of thinking, did you know that America is one of the few countries in the world where a 30 year mortgage is common? Most countries see much shorter terms – averaging 10 to 15 years.
This kind of “big mortgage” thinking combined with the idea of juicy tax breaks is exactly what the mortgage and banking industry wants you to believe. Remember, your debt is their bread-and-butter. Remember also that a borrower is a slave to its lender and the banking industry wants you in as many shackles as possible. It’s how they make their money and their ability to turn a profit is dependent upon them keeping you enslaved to their system – hopefully for the entirety of your adult existence. Sounds fun? Read on…
Doing Math Is Easy, Beating Math Is Hard:
The standard tax deduction for a married couple is around $12,600. That means if you don’t have write-offs / tax deductions of more than that amount, you are going to take the standard deduction on your tax return. Now, get this – almost 70% of all households fall into this category, so right off the bat a vast majority of all households see no benefit from the MID to begin with. Why the hype?
For those 30% who do have the benefit of filing with itemized deductions, let’s look at what the MID is worth to you. The average MID, according to Zacks Research, is around $12,000/year and the US Census Bureau tabulates the average property tax bill at around $3,000/year. That’s a workable average total of $15,000 in interest + taxes (MID+PT).
First, let me get this off my chest…. At a current average rate of 4.1% on a 30 year mortgage, an average MID of $12,000 puts the average mortgage being itemized at around $290,000. #coughcough… Damn son…
In a “middle” 25% tax bracket your standard deduction of $12,600 is worth $3,150 and the value of that $15,000 worth of MID+PT is $3,750 in deductions. That is a net savings of $600. One dollar spent spent in interest + taxes in order to save 4 cents on your tax return. A good deal?
Pause here for a sip of coffee as you ponder the benefit of that $1,000/month in interest…
The Tax Policy Center tabulates the average net value of the MID for middle class taxpayers at around $51/month with the average mortgage, according to Lending Tree being $1,061/month. This is not a solid ratio for wealth building….
What To Do:
Do me favor, the next time you hear a financial planner extolling the benefits of mortgage interest in terms of the money you’ll be able to save on your taxes, make sure he/she has fresh batteries in his/her calculator, then grab that thing and do some math.
The pursuit of a large and expensive debt for the primary purpose of claiming a small tax deduction is asinine and I have never understood why the myth of the mortgage interest deduction benefit is continually fostered upon the American public.
A Real Life Look:
As a Man on the Move, I put as much money down on my home as I could possibly afford (around 35%) and financed with a 15 year mortgage. I paid it off very early by making extra payments and then from time to time hitting it with larger lump-sum ammunition when it became available. This shortened my term and effectively lowered my interest rate as well.
The day I saw my cash on hand exceeding my mortgage balance I paid it off and collected my deed release documents from the bank as quickly as possible. I sent my lender the money by wire and asked for the papers to be Fedex’d back to me – I wanted out of those chains as quickly as possible, and that freedom feels oh so good my friends… Oh so good! Never once did I consider money I was saving on my income taxes as a reason for spending money on interest – that is a fool’s game. I don’t spend dollars in order to save pennies.
How To Profit:
Owning bonds means you’ll get paid by letting others use your money. I’ll choose not to take part in the recklessness of the MID – I want on the other side of that trade, the profit side.
As a vehicle, I like Jeffery Gundlach’s TOTL etf, which is 60% weighted toward residential mortgage bonds and commercial real estate debt. Investing in mortgage debt lowers your sensitivity to rising interest rate risk (and I think rising rates are inevitable), and your bond risk is further protected by the relatively short nature of the mortgage securities (30% less duration risk than an aggregate bond fund). TOTL pays a yield over 3% and YTD has returned 1.05% in gains against an aggregate index bond return of a mere .4%. Now that’s my kind of mortgage – one that sends money MY way… Man on the Move style…
In upcoming blog topics, we’ll look at other financial fallacies like student loan debt, the car lease, 0% financing offers, cash-reward credit cards, life insurance policies, credit scores, and multi-level marketing. We’ll piss off as many “experts” as we can and we’ll save AND make money doing it – investing with common sense and making our money work for us.
Let’s get on the move!