Mortgages and Taxes... Confused

[firebirdgold]

My fi and I are having a small financial disagreement, and I was hoping a PSer would know the answer. He says it makes more economic sense to pay a mortgage on a house and get an income tax refund on the interest. I say that the tax break does not equal or exceed the money you''re paying in mortgage so you''d end up with more money to spend rather than less if you weren''t paying for housing.

To clarify: I have a rather low income but I own a very nice house outright. He makes a quite good income and pays mortgage on his house. We''re selling his house and keeping mine since mine has a better location. However he''s not happy with all the money that will get sucked away once he stops paying out on a mortgage.

So essentially the question is: Would you have more money to spend or save in a year if you a) paid a monthly mortgage but got an income tax break, or b) didn''t have to write a check every month for housing but also didn''t get a tax break from the irs?

 

[Dee*Jay]

Let me say up front I am NOT an accountant and the goal of this post is NOT to offer you tax advice.

That being said, here's an example using easy numbers.

$1,100 = monthly mortgage payment
$100 = amount of the payment going toward principal
$1,000 = then equals the amount going toward interest
25% = your tax rate

Using these numbers $250 = amount per month you can write off from your income*

And you are paying down $100 month on the loan

Therefore you are paying $750 more per month than if you didn't have a mortgage ($1,100 - $250* - $100 = $750)

No mortgage = $0 monthly outlay (except of course for real estate taxes, and homeowners' association fees, maintenance, etc., but you would have to pay those with a mortgage too) BUT* you are also foregoing the $250/month write off if you had a mortgage, so really you're saving $500/month.

That was a very simplistic example and there are other variables that change things a bit, but I hope that makes sense.

 

[Maria D]

I don''t think this can be accurately answered without talking actual numbers. It also depends what you plan on doing with the money you borrow. You don''t need it to pay for the house because it''s already paid for. If you invest that money, it may be possible that the earnings on the investment plus the tax benefits outweigh the interest you''ll have to pay. I think a financial advisor can help you a lot more than a poll; good luck!

 

[Sundial]

I am not an accountant or financial advisor either and your best advice is to consult one of them regarding your own personal situation. However in my experience I have to agree with DeeJay that the tax benefit is not as great as the interest cost you will pay on a mortgage loan. And yes if you owned the home free and clear and took out a mortgage and decided to invest the funds you could recoup some of that interest cost, but most typical low risk investments do not return as much as you would be paying the bank.

 

[Mara]

for us we pay out way more in our mortgage and prop taxes and HOA than we get back at the end of the year in tax return. we get a nice tax return but our monthly expenses are really high.

another variable...if someone is in the first ~5 years of their mortgage because if so you pay WAY more interest than principal in those first 5 years. but we are still in our first 5 years and we still pay out way more than we get back. BUT we pay less out NET than it would cost to RENT what we have. so we are getting more back than if we rented. but if we owned outright, no way would we break even or make more $$.

 

[zdrastvootya]

I hope I''m understanding your question correctly, but here''s a question. If it was advantageous to take out a mortgage on a house you already own, wouldn''t everyone be doing it? I guess it depends on what you''re doing with the money you take out, but I''d think that you''d need an investment with very good return to make this worthwhile. Z.

 

[Tacori E-ring]

I am not sure if I understand either. Can he rent out his house so he doesn''t have the mortgage but still gets a tax break?

 

[sumbride]

Would you have more money if you didn''t spend it? Yes!

Getting a refund on interest isn''t the same as getting free money. If the alternative was paying rent, then yes, the mortgage makes the most sense, but taking out a loan you don''t need just for tax purposes doesn''t make sense. If you were to use it for home improvement purchases, thus boosting the value of the home and thus later generating wealth, than that makes sense, but in general, no. The house is paid for, invest the money in a higher yield area. The IRS isn''t in the business of giving away money.

(i''m not an accountant, just trying to reason my way through this...)

 

[codex57]

DeeJay had a great example. At the beginning of a mortgage, that's when you get the biggest tax benefit. However, in Cali and other high priced areas, the cost of a mortgage is so high, you'll have a ton more money to play with every month if you just rented.

Taxes aren't the reason you purchase a house. Anyone who thinks so needs to make an appointment with a CPA immediately. Not a financial advisor. No offense to FA's, but a financial advisor is really just a fancy name for insurance salesperson so they likely don't have the necessary knowledge of taxes to give you a good reading on your specific situation. Anyways, the main benefit of buying a home instead of renting is the appreciation of that home. That and the idea that eventually you will pay off that house and no longer have to pay any money for your living place at all. Tax savings are really more of a side benefit.

Right now, home prices are pretty flat or down in many parts of the country. If you can, it's best to be investing elsewhere instead of hoping for house appreciation. You have a home free and clear right now so no need to pay rent. You can always take the money you're FI is saving by not paying a mortgage and invest elsewhere for now, and when the real estate market heats up again, jump back in with a rental house or something.

 

[Beacon]

You are correct.

b/c you only get a tax advantage equal to your marginal income tax bracket, you never recover 100% of your monthly interest expense on the mortgage. If you have no payment, and instead put that payment money in the bank monthly you will be much better off. Over long period of time, especially with compound investment returns you will be much, much better off.

If you are thinking of doing a cash out mortgage for tax purposes - bad idea. You''ll only be able to take a 100K mortage b/c you have no "purchase money" mortgage on your place already. You can take out more mortgage, but only interest on the first 100K would be deductible. There are some exceptions to this, but they are complicated.

You have some different and tougher issues to deal with anyhow. Since you own the house prior to your marriage it is your sole and separate property. If you want to keep it that way (advisable) you will have to be most careful if you put a mortgage upon it. Since he has higher income, he might want to apply for the loan with you. If he goes on title when you close the loan, there goes your *sole and separate* property. If you put on mortgage by yourself he will have to quitclaim at the close of escrow. Very touchy subject in a new marriage.

Mortages make sense if they are the only way you can afford the home (most cases) or you are worried that the property might be a problem and don''t want to tie up capital in it. If you are a financial wiz you might prefer a mortgage b/c you can get a much higher rate of return on the capital that would otherwise be dead money in the house.

This is not tax advice!!!! Consult your accountant.

 

[nejarb]

you don''t get a tax deduction for interest payments in connection with a mortgage on a rental property. it must be your primary residence.

 

[nejarb]

sorry, that last response was in response to tacori E-ring''s response. i''m still learning how to communicate on PS

 

[Beacon]

Actually, if her Fi kept his house and then rented it out, he could take a deduction of the mortgage interest expense against the rental income. If they end up losing money on the rental, (and their income is less than a certain amount) they could take the rental loss off their personal tax return.

But her fi would be unwise to rent out his place if he has owned it for a while and it has apprecitated, cause he would lose his 250K cap gain exclusion if he rented it out more than 3 years.

Like I said - go to accountant.

 

[fire&ice]

Actually, we have paid off our house once & choose to put a mortgage back on. Also, we chose to put a mortgage on our second home.

Why? Lots of variables that financially make sense to us. Some of which DOES include the tax break - many times it pushes you into a different tax bracket - or let''s you itemize. Also, interest rates were at an all time low. So, you have to look at your opportunity cost. 4.5 interest rate - get the tax break - & even if you put the money in a CD at 5.5% - it makes sense. Credit building also.

So, really - you have to run the numbers, figure out your tax liablity & bracket & assess your opportunity cost with the money that you free up.

 

[Maria D]

Date: 9/15/2006 6:21:33 PM
Author: fire&ice
Actually, we have paid off our house once & choose to put a mortgage back on.

Same here, for the same reasons F&I mentioned. Another thing to consider is your current debt load, if any. If you''ve got credit card debt or any loans outstanding it''d be advantageous from both a tax and interest rate standpoint to borrow against your house and pay off these loans.

 

[Dee*Jay]

Indie, Fire & Ice and Maria D are right -- if you can make more on the money that you've taken out as a mortage than the rate that you're paying for the loan it does make sense, as does paying off higher debt rates with a lower one. I probably should have addressed those points in my original post but I was afraid to muddy the waters even more beyond the confusion I'm sure I caused by my convaluted example!

 

[Beacon]

This is true, but it is a tricky thing. If she wants to go above the 100K limit on deduction that she has now, she''ll have to segregate the money that comes out of the cash out loan and invest it in some way, e.g stocks.

It can definitely be good to have the mortgage, but it so much depends on the user''s capabilities and resources. If they are not able to invest the funds above their mortgage cost, it is bad. Some people, seeing a big wad of cash around start to spend it. (on stones?

_

Much care needed as her question simple on one hand - tax break does not equal total interest - but gets quickly into very complicated areas.

 

[codex57]

Date: 9/15/2006 7:24:10 PM
Author: Beacon

It can definitely be good to have the mortgage, but it so much depends on the user''s capabilities and resources. If they are not able to invest the funds above their mortgage cost, it is bad. Some people, seeing a big wad of cash around start to spend it. (on stones?

_


Much care needed as her question simple on one hand - tax break does not equal total interest - but gets quickly into very complicated areas.

Yeah, I didn''t want to get into other areas too much. Around here, tons of people take out home equity lines on their homes. However, instead of investing that money or paying down high interest debt like credit cards, they blow it on crap like plasma TV''s and new cars. They treat it like free money instead of loan proceeds.

 

[divergrrl]

Date: 9/15/2006 5:29:50 PM
Author: codex57
No offense to FA''s, but a financial advisor is really just a fancy name for insurance salesperson so they likely don''t have the necessary knowledge of taxes to give you a good reading on your specific situation.

You know, this is funny...I get the same financial advice from my CPA (for free) that my friends pay their FA''s for. And she only charges me $90 to do my taxes each year. Love that woman.

Granted, we only have my spouse''s 401k and my Roth IRA, but until we win the lottery and have big bucks to invest, she''s helped this normal couple with normal finances & saved me a lot of money.

In my opinon, it''s always better to pay off your house. Yeah we get a good tax return each year, but not so much that it''s more than the mortgage I pay all year long. We do 1 to 2 extra payments a year on our principal, so we can pay off our mortgage earlier. Our goal is to have our mortgage paid off (we adore our home & its really big, so no need to move) by the time our son hits college (we have 18 years). (so we''ll have his college already saved up for, as well as no mortgage)

I''d love to have NO MORTGAGE. I just learned the joy of No Car Payments 2 years ago & I will never have another one again. It''s heaven. (so I don''t drive a hot car, but it''s still nice enough for me).

No Mortgage...wow....owning a house outright, that''s just flat-out awesome!

Jeannine



Jeannine

 

[Regular Guy]

Date: 9/16/2006 1:09:20 AM
Author: divergrrl

Date: 9/15/2006 5:29:50 PM
Author: codex57
No offense to FA''s, but a financial advisor is really just a fancy name for insurance salesperson so they likely don''t have the necessary knowledge of taxes to give you a good reading on your specific situation.

You know, this is funny...I get the same financial advice from my CPA (for free) that my friends pay their FA''s for. And she only charges me $90 to do my taxes each year. Love that woman.

We should probably get one of these guys again...had one a number of years ago, and when taxes ostensibly simplified a bit, we''ve gone to turbo tax for several years. But, maybe we should go this route, again.

We''ve gone from pretty conservative...to being a bit out on a ledge.

Maybe three years ago we refinanced our home to 15 years and 4 1/2 percent...and it would have been perfect to stay put.

But, we didn''t like the middle school coming up. Moving across town is the option we went for. We can afford it, barely, but it means a 30 year mortgage, and my wife and I are 46 & 50 respectively. I think the implications are now threefold:

a) we''ll need to readily consider leaving here in a dozen years, after the kids are college age, and we don''t have to pay for the real estate to be in an area with more choice middle and high schools

b) we hope property values will at least stay level, if not go up, and indeed, not go down

c) if they do go down, for unexpected reasons, our 30 year commitment, so far as I know, will then be binding, leaving us committed to make high payments through ages 76 - 80 respectively. Maybe a small chance of this happening...but I have to think it is possible.

Frankly, my wife''s government salary has made this move possible. She needed to sign off on the change. She did. And I was on board for it. We could have bought more modestly to move to this school district, but this house is more choice, albeit only about the same size as our last, give or take, but reconfigured (cape code to a rambler). To my mind, this was not a conservative move. I think the risk was measured. But with risk it was, indeed.

 

[fire&ice]

One should not be afraid of debt. One just needs to understand it.

Honestly, do the numbers and evaluate your "personality". Are you the kind to spend the money on "stuff"? Or- are you the kind to invest the money to make you more money? What mortage amount can you afford?

 

[gailrmv]

It seems like common sense - it is much better to pay $0 every month than to pay anything (no matter what kind of tax breaks there are....)

 

[portoar]

This is a complicated question, and one that is best answered by a tax accountant or financial planner.

To know whether it''s better to pay on a mortgage or be mortgage free, you need to know:

1) what is the interest rate on the mortgage?
2) what is the forecasted appreciation rate on the home?
3) what interest/income can you earn on alternative investments?

If the interest rate on the mortgage is less than the interest you can earn by investing the money (the equity in your home) somewhere else, you might be better off pulling out some equity, paying interest on the loan, and investing the money somewhere else, while at the same time taking a tax writeoff on the interest you are paying.

You really do have to have some hard figures on hand to know what is the best move financially. Find out the value of your home, the value of his home, local rental rates, mortgage rates, take all the info to a financial planner and have them run some scenarios for you. If you rented his home, what rental income would you have and how much could you write off each year (depreciation, interest, expenses).

If you took a loan out on your home and invested the equity, would you have a net gain by investing the money and writing off the interest?

No one can answer these questions for you on pricescope.

 

[hoorray]

The situation depends on the actual numbers, as mentioned many times above. What I did not see mentioned was the leverage of having a mortgage if your home is in an area that you expect to have equity gain through appreciation.

If you put 25% of the value of your house in equity that you pay for and your house goes up in value, the return on the money that is tied up in the investment is different than if you put 100% of the original value into the house with your cash. The big benefit is that you can use the other 75% of the cash for other investments that would hopefully pay more than the after tax cost of our mortgage payments.

This doesn''t apply to all markets, and shoudl be taken into consideration after your big picture financial picture (cashflow, security, etc.) but in growing markets, it can be an important consideration.

.

 

[firebirdgold]

Wow, so many great responses! Thank you!
Personally I tend not to worry too much about investments. As I said I have a nice amount of assests inculding 2 money management accounts and a stock/mutual fund account. (Thanks to my economics genius father I got out of the tech bubble just in time!) While I feel more than a little guilty about it (since it''s his income), I wouldn''t mind having more monthly money to spend since I reinvest almost everything back into my fledgling business. I use my savings/investment earnings to supplement what I take out and I find it stressful. It''d be nice not to have to worry as much about paying bills. He also maxes out his 401k every month, but beyond that doesn''t believe in investing.

I''m afraid that money is the one thing we can''t manage to talk about beyond monthly budget and even then it''s hard. He believes that money is bad and could care less about his income level. It doesn''t even bother him that he''s seriously underpaid compared to his peers and management issues have prevented him from getting his phd raise, other than that he feels a bit under appreciated. And I was brought up to never talk about money.

I just looked up the tax brackets and not paying mortage might jump him up a bracket on his own.. it depends on how it''s calculated since his current (before anything) salary is above the cut-off. Figuring in a raise that doesn''t bump us above the joint bracket we''d currently be in, filing jointly will save almost 5k. I bet that''s equal to or better than what he''s getting back from a mortgage now!

I don''t think that when he talks about wanting a mortgage he''s saying he wants to take one out of my house. The two things he''s thinking of is either us buying a new place together or buying investment property on the coast. Which as some of you have said the latter won''t give a tax break.

Well, thanks to you, I now have some ammo or at least some confidence in my position for the next time we attempt to talk about this situation.

 

[Allisonfaye]

Date: 9/18/2006 12:09:58 PM
Author: IndieJones
Wow, so many great responses! Thank you!
Personally I tend not to worry too much about investments. As I said I have a nice amount of assests inculding 2 money management accounts and a stock/mutual fund account. (Thanks to my economics genius father I got out of the tech bubble just in time!) While I feel more than a little guilty about it (since it''s his income), I wouldn''t mind having more monthly money to spend since I reinvest almost everything back into my fledgling business. I use my savings/investment earnings to supplement what I take out and I find it stressful. It''d be nice not to have to worry as much about paying bills. He also maxes out his 401k every month, but beyond that doesn''t believe in investing.

I''m afraid that money is the one thing we can''t manage to talk about beyond monthly budget and even then it''s hard. He believes that money is bad and could care less about his income level. It doesn''t even bother him that he''s seriously underpaid compared to his peers and management issues have prevented him from getting his phd raise, other than that he feels a bit under appreciated. And I was brought up to never talk about money.

I just looked up the tax brackets and not paying mortage might jump him up a bracket on his own.. it depends on how it''s calculated since his current (before anything) salary is above the cut-off. Figuring in a raise that doesn''t bump us above the joint bracket we''d currently be in, filing jointly will save almost 5k. I bet that''s equal to or better than what he''s getting back from a mortgage now!

I don''t think that when he talks about wanting a mortgage he''s saying he wants to take one out of my house. The two things he''s thinking of is either us buying a new place together or buying investment property on the coast. Which as some of you have said the latter won''t give a tax break.

Well, thanks to you, I now have some ammo or at least some confidence in my position for the next time we attempt to talk about this situation.

As far as your buying a new property, if you are thinking of paying cash and having no mortgage, you have to look at the return you could get by investing that money elsewhere and compare it to your aftertax costs of a mortgage.

As far as getting a large tax refund as a few people mentioned, it isn''t generally a good idea to give the government an interest free loan (from and investing standpoint).

Regarding your relationship and your inability to discuss money, I would work on that issue before I got married since money issues are the #1 cause of divorce (per Dr. Phil).

 

[fire&ice]

Investment property has it''s own set of tax benefits. Now, if you were to buy a second home for your use, that interest income is deductible.

 

[Small]

Date: 9/18/2006 5:12:31 PM
Author: Allisonfaye

Date: 9/18/2006 12:09:58 PM
Author: IndieJones
Wow, so many great responses! Thank you!
Personally I tend not to worry too much about investments. As I said I have a nice amount of assests inculding 2 money management accounts and a stock/mutual fund account. (Thanks to my economics genius father I got out of the tech bubble just in time!) While I feel more than a little guilty about it (since it''s his income), I wouldn''t mind having more monthly money to spend since I reinvest almost everything back into my fledgling business. I use my savings/investment earnings to supplement what I take out and I find it stressful. It''d be nice not to have to worry as much about paying bills. He also maxes out his 401k every month, but beyond that doesn''t believe in investing.

I''m afraid that money is the one thing we can''t manage to talk about beyond monthly budget and even then it''s hard. He believes that money is bad and could care less about his income level. It doesn''t even bother him that he''s seriously underpaid compared to his peers and management issues have prevented him from getting his phd raise, other than that he feels a bit under appreciated. And I was brought up to never talk about money.

I just looked up the tax brackets and not paying mortage might jump him up a bracket on his own.. it depends on how it''s calculated since his current (before anything) salary is above the cut-off. Figuring in a raise that doesn''t bump us above the joint bracket we''d currently be in, filing jointly will save almost 5k. I bet that''s equal to or better than what he''s getting back from a mortgage now!

I don''t think that when he talks about wanting a mortgage he''s saying he wants to take one out of my house. The two things he''s thinking of is either us buying a new place together or buying investment property on the coast. Which as some of you have said the latter won''t give a tax break.

Well, thanks to you, I now have some ammo or at least some confidence in my position for the next time we attempt to talk about this situation.

As far as your buying a new property, if you are thinking of paying cash and having no mortgage, you have to look at the return you could get by investing that money elsewhere and compare it to your aftertax costs of a mortgage.

As far as getting a large tax refund as a few people mentioned, it isn''t generally a good idea to give the government an interest free loan (from and investing standpoint).

Regarding your relationship and your inability to discuss money, I would work on that issue before I got married since money issues are the #1 cause of divorce (per Dr. Phil).

I have an accounting degree but I don''t know all the tax laws anymore since I don''t work and haven''t worked in 3 years since my daughter has been born.
It''s always best to consult a CPA/tax accountant for these questions.
For us, we need the mortgage interest. My husband''s income would put us in a bracket where we''d have to pay if we didn''t have so many itemized deductions. I''m sure we''d save quite a bit if we didn''t have the mortgage but we''d definitely pay at the end of the year without the interest deductions. It''s a mute point for me anyway since we can''t afford to pay our mortgage off at this point LOL
Your goal should NEVER be to get a refund at the end of the year. It should ALWAYS be to break even or owe the IRS just a very little bit. This is where investing and such do come in handy as they give you tax breaks and you are saving money tax free. The Gov''t is using all of our money all year long when we could easily be investing that money and using it for other things. If you have a savvy accountant you can figure out what to do to NOT get a refund and to break even at the end of the year regardless of your tax bracket. I have 2 kids which helps out immensley as does my mortgage interest and my high property taxes. I get a pretty hefty refund back BUT the amount of money he pays in every year is INSANE! Once both of us are working and our kids are a bit older I''m going to go back to getting our money to work better for us by not paying in so much and breaking even at the end of the year. It really is the best solution to make your money work for you

 

[diamondseeker2006]

It is always best to be debt-free! I''ve heard this question asked many times on financial shows, and the answer is, pay off the highest interest debt first, and then if all that is paid off, then work on the mortgage. We paid off our house last year, and we are in a high tax bracket, but it still makes no sense to pay mortgage interest to save on taxes. It almost never works out to save you money as the interest is more than the tax it saves.