I recently received mortgage solicitations in the mail from two different companies on the same day. As a player in the mortgage industry I like to see what my competition is doing. As a result I analyze all mortgage related marketing material that comes across my desk. For some reason both mail pieces were super hyper in selling their potential customer on the idea of the mortgage tax deductions. Both mail pieces expounded on the idea that by utilizing your home to finance various goals you will in effect reduce your tax bill. Ironically, as I was reading various financial publications I subscribe to, I came across an article written by a financial advisor who was illustrating the benefit of making minimum payments on mortgages while investing all you can in various investment vehicles. This financial consultant reasoned that since interest rates on mortgages were averaging 6-percent and that long-term investment vehicles were averaging 12 percent you are in effect netting a 6 percent return.
I hold a unique position. I’m one of few financial experts who are versed in multiple financial disciplines. That being saidçmy views oftentimes differ from financial professionals who operate in one zone whether it’s mortgages, insurance, real estate, taxes or investing. I will admit that to some degree the concept of the mortgage tax deduction and the concept of investing versus paying off the mortgage have merit. I will also admit that having a plan is better than having no plan at all. However, I question whether or not this is the most simple, efficient, risk tolerant way to manage your money.
The truth about your mortgage
interest tax deduction
Millions of consumers are sold on the idea that some large tax deduction exists when you pay interest on your mortgage. While it is true that by paying mortgage interest you reap a tax deduction, the question mark lies in the adjective “LARGE”. It is important to note that NO tax incentive will be equal to or greater than the interest expense that is paid. More importantly it should be pointed out that there are two types of deductions that exist—a standard deduction and an itemized deduction. When filing your taxes you have to choose one or the other. Naturally, you would want to choose the deduction type that yields a greater benefit. The standard deduction is a specified amount, indexed annually for inflation that may be claimed by taxpayers that do not itemize their deductions. The only time you will claim itemized deductions is if your itemized deductions exceed your standard deduction. The amount of the taxpayer’s deduction is based on filing status. For a married filing jointly taxpayer, the standard deduction in 2006 is $10,300. Given the fact that most deductions have to have a profit motive associated with them such as deductions available for investments or businesses. Deductions available for homeowners including property taxes and mortgage interest are the primary deductions available for the average person. For the sake of simplicity, let’s assume you’re married filing jointly and that other than mortgage interest, you have no other itemized deductions. Let’s further assume that you are in the 25 percent marginal tax bracket. Given this scenario, you will have to pay interest over and above $10,300 (amount needed to exceed standard deduction) before the itemized deduction will began to benefit you. Assuming you paid $12,000 in interest for the year, you may reason that you reaped a $3,000 tax deduction ($12,000 x 25 percent tax rate = $3,000). The reality in this scenario is you would have gotten a $10,300 deduction whether or not you paid interest. Therefore, the benefit should be calculated on $12,000-$10,300 which is $1,700. The actual tax saving in this example paying $12,000 in interest is a whopping $425 ($1,700 x 25 percent tax rate = $425) If I lost you in the financial jargon, simply ask yourself does it make sense to pay $12,000 in interest to get a $425 tax savings? I hear a resounding NO.
You can earn a greater return paying off debt than you can earn in the stock market