The Mortgage Interest Deduction Farce

house irs mortgage interest

“Buy a house” they said. “You’ll be able to deduct the mortgage interest” they said. Probably one of the greatest lies ever told, and possibly a lie you believed.

This is how many prospective homeowners think about things:

  • Buy a house.
  • Pay mortgage interest.
  • Deduct said mortgage interest from taxes.
  • Convince yourself this is an amazing benefit.
  • Tell people who don’t have mortgage interest they suck at being awesome.

The reason I love personal finance is because of it’s inherent objective nature. One can’t say they are financially stable if they have significantly more money going out each month than they are bringing in. Subjectivity is limited when it comes to cold, hard numbers. Let’s look at the mortgage interest deduction from an OBJECTIVE stance.

Let’s pretend Girl Ninja and I buy a $350,000 house tomorrow. We put 20% down and get a 3.75% interest rate on our loan. Wanna know how much mortgage interest we pay in the first year? About $10,300. Sure we could deduct that amount from our taxes, but why would we? The standard deduction we get is already $12,200. Oh, and don’t forget as each year passes the amount of mortgage interest you pay DECREASES which means your mortgage deduction benefit DECREASES. What a great deal, right? Hahaha!

So what does all this mean? It means the mortgage interest deduction benefit (if you can call it that) is essentially worthless. The numbers don’t lie. Only 25% of tax filers actually include the Mortgage interest deduction on their annual taxes. Or in other words, most people DON’T realize any benefit from having mortgage interest.

Obviously if you donate 10’s of thousands of dollars each year, or if you buy a million dollar home, you will get a benefit from the deduction, but that is not the case for most people, and probably wont be the case for you.

I’m not saying you shouldn’t buy a house. Just don’t let stupid people try to convince you that mortgage interest is a “perk” to homeownership.

p.s. Here is a video of me not sticking the landing after skiing off a small rock yesterday. Ninja skiing.

 

41 thoughts on “The Mortgage Interest Deduction Farce

  1. Ninja,

    How about $10,000 + your real estate tax + your state income tax (ahem – sales tax for you) + your charitable donations? Sure, you won’t get the full benefit of the $10,000 – but it sounds like you’re on your way to writing off something.

    • I guess I forget about state income tax since there is none here in Washington.

      But we can’t pretend that most Americans donate thousands of dollars each year. Heck the average American doesn’t even buy a $350k dollar house, they buy a $270k house, further reducing the chances of getting a benefit.

      The Mortgage interest deduction is beneficial for people who buy über expensive homes, or those who donate 10%+ of their six figure income.

      Run the numbers for the average American (income, mortgage, charitable giving, etc) and you’ll see that they get nothing out of it.

      • Depends on your state. In NY, I have high state income tax which is federally deductible. My home was not über expensive (congrats on using the umlaut) by any means. But between mortgage + property tax + NY state tax + charitable, even after 23 years in the same home I still have enough deductions to pass the standard threshold. I have never however even come close to the 7.5% floor for unreimbursed medical, which I suppose is a good thing. And as PK notes, don’t forget your WA sales tax.

        • And also there’s your points and closing costs when buying a house. It’s only for a year, but it’s something. You may every once in a while have miscellaneous deductions like job-hunting expenses (if they’re over 2% of AGI); and not that I would wish this on anybody, but there might be casualty and theft.

          I haven’t done this year’s taxes yet, but my personal situation may be a bit unusual in that, as a shareholder in a coop, I pay a deductible share in the underlying mortgage for the property, and that’s likely to persist in perpetuity. But I have found in the past few years that I can no longer itemize on my NY state taxes, and naturally my federal deduction has gone down over time.

          • Yeah, I’m in a similar boat. We live in California, which is (ready for some hyperbole?) an automatic itemizing state! (Actually, Virginia leads the pack with 37.55% of returns with the MID in 2007).

            CA income tax + property tax + charity + MID is a monster. We also paid .375 points on the front end, but we bought this house in 2011… but I itemized even before this house.

        • We hit that medical amt for taxes this year, sadly. We also can deduct our mileage for said doctors appointments and hospital visits. We also deduct our interest on our school loans.

      • Yeah, I’m with you. The non-saltwater states, especially.

        When you look at who benefits the most from the MID it’s pretty absurd, considering Canada doesn’t have an MID and also has higher home-ownership rates. I bet the regular income tax starts to look more like the AMT (eventually) – no property tax, no state income tax, etc.

      • I live in Washington state as well and you can deduct sales tax. There’s a calculator on the IRS website: http://www.irs.gov/Individuals/Sales-Tax-Deduction-Calculator That will probably give you a ~$1,600 deduction.

        I have a somewhat small mortgage and don’t itemize much, but I am still over the standard deduction for a single person. For married, it’s harder, yes, but you and Girl Ninja will most likely be able to itemize.

        A $350k house will most likely have property taxes of at least $3,000/year and you guys tithe, which is enough. So $10,300 interest + $1,600 sales tax + $3,000 property taxes = $14,900 itemized + tithing. It doesn’t really save you much money, but it will save you SOME. I completely agree with you that mortgage interest isn’t a reason to buy a house and I most likely won’t pay enough to itemize for more than 3-5 years.

    • Mortgage deduction, plus state tax deduction, plus tuition deduction, plus charitable contribution deduction, plus home energy improvement deductions has added up to more than the standard deduction for us for many years now. It’s not a single reason to buy a house, but it’s something to offset a little of the costs.

      Owning a house isn’t cheap, and it doesn’t feel like much of an investment these days.

  2. Aww man, how I truly wanted to use that argument to justify upgrading to a new home… Maybe by the time we buy our homes the interest rates will go up higher then it would make more of an impact on our taxes…LOL! Talk about a catch 22…

    However, PK does have a point in regards to building up enough deductions but you need to have baby ninjas first ;P I can imagine those things are expensive too.

  3. How about… getting $0 in deductions back?

    In Australia the interest you pay on your home loan has never been something you can deduct. Also not sure what this “standard deduction” of $12,200 is either… Down Under if you cop $10,300 worth of interest… you pay it just like you would a bill for electricity.

      • Perhaps the ones that aren’t so good with money in the first place. I would *hope* that most people would rather be out of the mortgage sooner than take the interest deduction for a longer period of time, especially since the interest deduction is one of the parts of the US tax code that keeps coming up amidst the bickering in Congress. If I had to guess, the deduction is not going to be around much longer.

    • Standard Deduction is part of the US Tax Code that is basically a generalization of how much they believe a normal person (or couple) would spend per year in deductible expenses (charity, interest, medical expenses, local taxes, theft and losses, unreimbursed job expenses, tax preparation fees and other miscellaneous fees).
      You can take the standard deduction or you can list out to the IRS all your deductible expenses which is call itemizing. The only way to get the Mortgage Interest Deduction is to list it out.
      A deduction just lowers the amount of your income subject to taxes. Therefore a deduction is more valuable to those of a high tax bracket than a low (A $10000 deduction is worth a $3960 tax credit for the high bracket but only $1000 for the bottom bracket).

  4. Our first year itemizing, with 11 mortgage payments, we were able to deduct $17,600 for 2 people, and I have to do a 1040X to add another $1500ish in deductions that I wasn’t expecting to show up — a 1098 showed up the last day it could, didn’t know it was coming.

    You can deduct mortgage interest, property taxes, state income OR sales taxes, and PMI if you pay it. You can also deduct points you pay on your mortgage (even if paid by the seller as closing costs), as well as prepaid interest at closing.

    It’d be silly to not itemize until all those things added up is less than the standard deduction. It certainly would add up to more for the first probably 5-7 years at your price point.

  5. There you go again, letting math influence your decisions!

    I personally would love to see the tax code altered to get rid of this deduction, but then again I would also like to see the tax code get a drastic overhaul in general, but that is a different debate for a different day.

  6. Agreed that it should never be one of the reasons to justify buying a home. My husband and I haven’t ever gone through or started the home buying process, so I didn’t realize that was a selling point that banks use… pretty ridiculous. Hopefully most people see through that reasoning!

  7. When I tell people I’m working on paying my mortgage off early they inevitably say, “but you’ll lose your mortgage deduction”. This past year I paid $5,700 in mortgage interest. That is nowhere close to the $80k I’ll be saving in interest payments by paying it off in 8 years vs. 30.

  8. I’ve owned two properties – a single family home and a condo. I have never been able to deduct mortgage interest because the mortgages were so low, plus I paid off the condo in 8 1/2 years instead of 15. I hated paying the bank interest!

  9. While I would love to not have the mortgage deduction because my house is paid off, it is foolish for anyone to leave that on the table. I’ve been able to beat the standard deduction by itemizing ever since I started having to file taxes. Probably because I’m anal about keeping all my receipts and looking for every place possible to take my money back. Charitable contributions alone pretty much get me there, the mortgage deduction is just icing on the cake (that will be gone before the 30 years is up b/c this will be paid off early!)

  10. I’m filing as a single homeowner for tax year 2012. I bought a $128,000 house, and I’m getting a $500 refund. That’s about 1/6 of what I paid in mortgage interest last year – doesn’t seem like a good deal. While mortgage interest is deductible, folks also have to keep in mind that they have to account for all income which will eat into the refund.

  11. Yeah, I calculated how much interest we would pay if we bought a modest home, and our standard deduction is still way higher!

    In order to take advantage of the mortgage interest deduction we would have to buy a house 3-4 times what we want to buy!

  12. We tithe and coupling that with our mortgage interest and state income taxes, we’re way over the standard deduction (for now).

    Over time of course, the interest we pay will drop. But, we also qualified for a Mortgage Credit Certificate for first-time homebuyers who earn under a certain amount of money. That credit gives us a 20% tax CREDIT off our mortgage interest every year, deducting or no. We can also do the regular mortgage interest deduction, which does save us a chunk on our taxes.

    The MCC this year will save us $1,000.

    Of course, the tax benefits aren’t a reason to buy a house. Heck, they probably won’t even be around forever. But if it’s in the tax code, might as well enjoy it.

  13. I couldn’t agree more! There are many reasons to buy a home, but this deducting the interest is rarely one of them. We plan on buying our first home in cash (Ninja – I know you aren’t for that) and people tell us we shouldn’t because we could be deducting the interest……or we could be paying no interest at all! 🙂

  14. Itemized Deductions (Schedule A):
    1. Medical Expenses in Excess of 7.5% Adjusted Gross Income (10% in future years)
    2. Taxes Paid:
    2a. State Income Tax or State Sales Tax (If claiming income tax, a state refund is taxable in the next year)
    2b. Real Estate Taxes
    2c. Personal Property Taxes (Cars, etc.)
    3. Interest Paid (Mortgage, PMI, Points). Points are an interesting topic, you can either claim them all up front in the first year or amortize them over a 30 year period.
    4. Gifts to charity
    5. Casualty & Theft Losses (Excess of 10% Adjusted Gross Income)
    6. Job Related and Other Expenses in Excess of 2% Adjusted Gross Income

    The US tax system is an interesting monster. One that does need to be greatly simplified.

    Student loan interest can also be claimed (up to $2500 per return) but is taken as an adjustment to income rather than as an itemized deduction. This means the Tax Code supports prepaying a mortgage before prepaying student loans.

    In my case, the mortgage interest deduction is the reason I can itemize, but just barely. Unfortunately state income and local property taxes get me to 90% of the standard deduction and the interest just puts me over. Time to see if my employer will let me transfer to a lower cost of living location =P

    • Oh yeah and in Washington state (maybe others?), part of your vehicle tab renewal fees can be itemized. It’s minuscule for me, but still an extra bonus since my mortgage interest + property taxes put me over the standard deduction this year.

  15. You said only 25% of tax filers use the mortgage interest deduction (technically from the IRS stat data it is 25.9% in 2010). It is important to remember that the stat is of all tax payers not just ones that own a home with a mortgage. We have roughly 65% of the US population that owns a home and since roughly 34% of homes are paid off (Both percentages from the US census (American Housing Survey)) that means that only 43% of tax filers have a mortgage. Therefore more than half (60%) of those with a mortgage deduct the interest. 🙂 So if you have a mortgage most likely you take a deduction.

    Of course the mortgage interest deduction should never be a reason you buy the home since you still lose $7000 (according to your cartoon). Of course those that fall into that trap most likely also fall into the trap of buying something JUST because it is on sale for 30% off. (“Look I bought this doohickey for 30% off, it saved me $40!”, “What does it do?”, “I don’t know but I saved $40 on it!”, *face-palm*). I would like to say to those, “If you give me $1000 now on April 15th I give you $400. Look you even get a better return from me than from the government for paying someone else.” Nobody yet has taken me up on the offer.

  16. My situation (aka how crazy New York taxes are)
    Single, NY income tax 4500 + 5800 property tax already makes it beneficial for me to itemize before considering any other possible deductions. I live in western NY. I make about 70 and my property is assessed at 175k.

  17. You’re completely discounting your single readers! The single deduction is right around 6k, and I calculated that itemizing will benefit me for the first 7-10 years in my house. I agree that the MID may not help you, and it’s not a good reason to buy a house, but I’m looking forward to doing my taxes next year. (The money will go toward mortgage prepayment/house projects.)

  18. Exactly! That’s like saying getting a degree in underwater basket weaving and going thousands and thousands of dollars in debt to do it is good because you get a tax break from student loan interest. Luckily, I have never heard somebody advocate for this.

  19. I’m a tax accountant and I work with people who don’t accelerate payments on their mortgages or student loans solely for the deductions. They may know tax, but they lack basic financial sense.

  20. Ninja, I thought you and your wife tithed? 10% of 90ish thousand dollars plus a mortgage deduction would put you over the 12,200 you mentioned for a standard deduction.

  21. The “mortgage interest deduction myth” is my litmus test for basic financial skills assessment when I talk to people. When I was shopping for my house, one of my coworkers, who is a well educated, software programmer, was also looking for a new house – and spent a good 40 minutes trying to “explain” to me how the tax deduction on the interest, made it perfectly reasonable for him to take out a significantly larger loan than he would otherwise contemplate – and trying to convince me to do the same.

    My mortgage lender tried to sing the praises of this deduction, to convince me to take out a bigger loan – although to be fair, she didn’t try very hard and was *really* good about respecting my very conservative limits 😀

    My realtor and good friend,wondered why I wasn’t SUPER excited about the interest deduction.

    Basic math tells me that if I pay 10k in interest to the mortgage company, and pay 3k less in income tax, I still paid out 7k more in money than I would have, if I hadn’t taken out a mortgage. The mortage interest deduction by itself, doesn’t make me financially better off for buying a house and people really need to figure that out.

    My coworker btw? *seriously* stressed out financially due to the big mortgage he took out.

  22. In high income tax states, the mortgage interest deduction is a great bonus. Without it plus the property tax deduction, we wouldn’t be itemizing. Our PITI payment on a 1700 sf house is only $200 more per month than our 900 sf apartment but a big chunk of that is now tax deductible. It’s not the reason we purchased a home but it DOES make home ownership more advantageous than renting.

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