Saturday, January 3, 2015

Home Ownership and the Mortgage Interest Deduction ... Caveat Emptor (Let the Buyer Beware)

There are many stories concerning the virtues of home ownership compared to renting, and indeed there are many good reasons to own. But there are many myths as well. One of the virtues, or perhaps myths, is the income tax deductibility of mortgage interest paid on loans. The bigger the better, or so the story goes.

What we don't often consider fully when making the buy decision, however, are the many myths associated with buying the 'house of our dreams' --- such as the bigger the mortgage loan in relationship to the purchase price, the more likely the home will be worth less than the amount owed on the mortgage, aka going underwater. Nor do we hear about how the longer the loan's duration and more affordable the monthly payments, the vastly bigger the total interest payments will be over the life of that loan.

But let's consider more fully just one of these virtues or myths today --- the mortgage interest deduction as a reason to buy instead of rent. It's time for some truth telling.

Why the mortgage tax break isn't helping many taxpayers tells the story of low interest rates and the value of the much hyped home mortgage interest deduction:

"For generations of U.S. homeowners, the tax deduction on mortgage interest has been a sacrosanct loophole that no one in Congress dare touch.

But the collapse in interest rates is producing a bizarre and, so far, underappreciated result. It is making that loophole less and less valuable.

Indeed, for growing numbers of homeowners the loophole is now almost completely worthless. The mortgage-interest deduction is no longer a middle-class tax break. . . .

Do the math.

Rates recently plunged to their lowest levels since May 2013, according to Freddie Mac. The rate on new 30-year home loans dipped as low as 3.8% . . . . Meanwhile, according to the National Association of Realtors, the median price on existing (i.e. secondhand) homes sold is $208,000.

So someone who buys a home with a typical 20% down payment will be borrowing $166,000. At 3.8%, they’ll pay $6,200 interest in the first year, and less and less interest each year as the balance slowly declines. (Only the interest payments on a mortgage are deductible, not the principal repayments).

OK, so if you choose to itemize your taxes each year you can write off that $6,200 (and declining) in interest.

But here’s the thing.

You will be able to write off $6,300 (for 2015) just by taking the standard deduction, thereby saving yourself a bunch of paperwork and hassle. And that’s if you are single . . . . If you are a couple filing jointly, the standard deduction doubles to $12,600.

Yes, there are a bunch of other issues in play, and everyone’s tax situations are different. For example, if you itemize your deductions you can also deduct your property and state taxes. And when you add those to your mortgage interest you may find itemizing taxes cuts your tax bill, even if you are married filing jointly. A married couple paying $6,000 in mortgage interest, $5,000 in property taxes and $5,000 in state income taxes can deduct $16,000 from their taxable income by itemizing, instead of just $12,600 by taking the standard deduction.

But for many people that gain will add up to, at most, a few hundred bucks in saved taxes.
Furthermore, if they chose instead to double up their state and property taxes every other year, which is perfectly legal, the tax benefit of the mortgage interest deduction would vanish completely.

Instead of paying $10,000 in state and property taxes each year, they could pay $20,000 this year and then skip next year’s. That way they can deduct a thumping $20,000 in itemized deductions from this year’s taxable income. Then, next year, they can just take the $12,600 standard deduction. So over two years they can deduct $32,600. They’ll end up paying less tax than they would if they had kept their mortgage deduction and itemized each year.

This math is new. As recently as 2008, 30-year mortgage rates were over 6%. In early 2000 they were north of 8%, and back in the early 1980s they were in double digits. Back then people were paying a lot of interest, and the deduction was really valuable."

Summing Up

The point is simple. Don't buy a house based on the tax advantages of home ownership compared to renting.

There are many disadvantages to home ownership, including not knowing how long it will take to sell it when the time comes to move, how much the selling price will then be, how long it will take to sell the house or how much it will cost for realtors and relocation.

Then there are the other costs homeowners 'enjoy' such as maintenance, repairs, renovations, insurance and property taxes.

Owning a house can be a pleasure. It can also be a pain.

Thus, tax breaks associated with buying should be left out of the rent versus buy decision, as should existing low interest rates, assuming this won't be the last home you will buy. If it is, then go ahead and buy.

Because unless this will be the last 'stop,' existing low interest rates will rise down the road, and then that same current positive affordability factor will result in a lower affordability factor for the next buyer. That in turn will probably mean a lower selling price when your time comes to sell.

Caveat Emptor. That's my take.

Thanks. Bob.

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