Thursday, November 15, 2012

Keeping the Mortgage for a Tax Deduction

Real estate is a favorite topic of mine. A question that often comes up is "should I keep my mortgage for a tax deduction?"

Most people are aware that there is a tax deduction for the interest paid on your mortgage every year. This often times will increase the likelihood of your ability to "itemize" your deductions (i.e. the ability to take more than your standard deduction amount of $11,900 if married filing jointly).

But is it worth it to keep a mortgage for the sake of a tax deduction? My answer is NO! but comes with complexity.

Here is why: Sure, that interest paid to the bank gets you a sweet tax deduction,  but it doesn't make financial sense to pay the bank $10,000 in interest to get a $3,500 cut on your tax bill. (calculated using a 35% tax rate, which is assuming you are rich and in the highest tax bracket, which statistically, most readers won't be!).

So that is it, we are all going to pay down our mortgages right? wrong! As much as I hate to admit, taxes aren't everything! Here is the minor complexity:

Generally speaking, you are likely to get more bang for your buck if you dump your money in that 401K, IRA, or some other investment. Most investments pay a better return than that rockin' 3.25% interest rate you are paying on the mortgage.

But, if you want a guaranteed return on your money, or you don't anticipate getting a return better than 3.25% (or whatever your actual mortgage rate is), then maybe paying down the house is a good idea.

(If you wanted to get real nerdy, you could dive deeper and calculate the after tax impact of paying down your mortgage, vs paying tax on your capital gains!)

Moral of the story: keeping the mortgage around ONLY for the tax deduction makes no sense. Its like asking for a quarter in exchange for a dollar.

(seeing as I do not have a mortgage, your experiences & criticism on this article are openly welcome)

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