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Mortgage Interest Deduction Myth

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Farm House with Rising SunThe mortgage interest deduction is one of the most celebrated tax deductions in all of tax deduction-dom. It’s cited as one of the benefits of homeownership, right behind “you’re not throwing your money away,” and that fact is repeated over and over again. Unfortunately, I believe it’s misrepresented. It’s not as good as you think and I’ll explain why.

To claim the mortgage interest deduction, you have to itemize your deductions. For those who aren’t familiar with the idea of claiming itemized vs. standard deductions, you have two options when you file your return. You can either list all of your deductions, such as the mortgage interest deduction, or you can just claim the “standard,” which requires no proof.

The reason why the deduction is a myth has to do with the size of the standard deduction, which you get even if you don’t own a home. Here are the standard deductions by filing status for 2009:

  • Single – $5,700
  • Married Filing Jointly – $11,400
  • Married Filing Separately – $5,700
  • Head of household – $8,350
  • Qualifying widow(er) – $11,400

I recently received my Substitute IRS Form 1098, which is a form my mortgage lender files with the IRS. The form lists, among other things, all the interest I paid towards the mortgage last year – $11,521.87.

If we didn’t have mortgage interest, we would claim $11,400 as our standard deduction and we get that for free. To claim the $11,521.87, we have to pay $11,521.87 to our mortgage company! If you assume we’re in the 25% tax bracket (2010 IRS tax brackets), here’s how we make out from a cash flow perspective:

Married Filing Jointly Single
Itemized Standard Itemized Standard
Interest Paid: $11,521.87 $0 $11,521.87 $0
Deduction: $11,521.87 $11,400 $11,521.87 $5,700
Tax Refund: $2880.47 $2,850 $2880.47 $1,425
Net Cash: -$8641.40 $2,850 -$8,641.40 $1,425
Difference: -$11,491.40 -$10,066.40

Interest paid is how much money was spent throughout the year for each case, so $11,521.87 for the homeowner and $0 for the renter (to use simpler terms). The deduction compares the mortgage interest deduction, of $11,521.87, against the standard deduction of $11,400 or $5,700, depending on filing type. The tax refund is simply 25% of that, since we are assuming the 25% tax bracket. The net cash is to the taxpayer. Take the refund they received and subtract the interest they paid. The delta is the difference between the homeowner and the renter.

As you can see, in both cases, the homeowner pays more. Much more. (and interest, unlike equity, isn’t something you get to keep)

Did you know that you can deduct real estate taxes if you claim the standard deduction? It’s Line 7 of Form L and you can deduct up to $500 (single) or $1,000 (married filing jointly) of your real estate taxes. This makes the mortgage interest deduction even less appealing since you can deduct part of your real estate taxes and claim the standard deduction.

Of course, that’s not the whole picture because there are many other factors. There are tax deductions made available to you whenever you itemize, such as charitable deductions. Also, when you rent, the idea of “throwing your money away” does have a bit of truth in it because you pay for a portion of the mortgage interest and property taxes without getting the deduction for it. Of course, at this point it is more a debate about the broader qualitative and quantitative aspects of the rent vs. buy question.

So why do people buy homes if there’s such a big difference? The difference in what homeowners pay in interest really amounts to what renters pay in housing costs. The table above omitted that because we were strictly looking at the interest deduction, not at housing costs as a whole. People buy homes because when you make those mortgage payments, part of it goes towards the home. When you rent, none of the payment goes towards owning more of that home or apartment. As the years pass and the principal portion of the mortgage payment increases, you get closer and closer to owning a home.

When you look strictly at the mortgage interest tax deduction, it just doesn’t add up financially.


(Photo: orvaratli)

{ 113 comments, please add your thoughts now! }

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113 Responses to “Mortgage Interest Deduction Myth”

  1. Ben says:

    Is this article written only for those fortunate enough to live in states w/ no state income tax? For many people, the state income tax deduction alone or combined with other itemized deductions may meet or exceed the standard deduction. If that’s the case, then potentially 100% of your mortgage interest deduction is “excess” deduction above the standard deduction amount. As Bsj2312 mentions above, assuming that mortgage interest will be your only itemized deduction makes absolutely no sense.

  2. jacko says:

    You are not making an apples to apples comparison. If you weren’t paying interest you would be paying rent. What has the person paid in the above scenario for rent? IF you take a similar product for rent and compare what the person pays in rent versus all of the costs of owning including the tax deduction then you will have a more accurate answer. The home owners who make good financial decissions overall will do better over teh long term because their property appreciates in value.

  3. Bob Roberts says:

    Looks like someone didn’t make it through high school and critical thinking.

    Notwithstanding the above arguments (which are both valid against your flawed assessment), the house you purchase has intrinsic value in that it is a roof over your head. This value continues to exist even after you’ve paid the loan off. So, even if you pay more in interest than you would in rent, after 30 years you’re still paying rent, whereas if you had purchased the house, your interest payments (and principal payments) are $0.

    You don’t get a free pass on rent after 30 years, do you? Not only do you have a place to live, you also have the have the cash value of the house, which you own outright.

  4. BillBo says:

    The real question isn’t so much about rent vs buy as it is carrying a mortgage *just* to get the interest deduction vs paying off your home.

    For just about any mortgage, you are paying interest (tax-deductible) and principal (which is not). Simple math shows that in any given tax year, your tax savings MUST equal your total interest paid PLUS your principal paid *just to break even* overall. The interest deduction simply lowers taxable income. It is not a dollar-for-dollar reduction of your tax liability.

    Carrying a mortgage to purchase a primary residence is acceptable because it is a tangible asset (thus the “real” in real estate), but carrying a mortgage just for tax purposes is a losing proposition.

  5. Mark says:

    I agree with Billbo and will take it one step further.

    The principle and interest (P&I) portion of your payment remains the same throughout the loan for typical fixed mortgage. Your monthly payment today requires a greater % of your overall income. In 30 years, that same payment will require a much smaller % of your overall income.

    For example, $150,000 today will be the equivalent of $364,089 in 30 years.

  6. Woody says:

    I don’t know what form you are looking at, but line 7 of form L is deductions for taxes paid for a CAR purchase for the 2010 tax year.

  7. Randy says:

    Just found this article looking for news on what might happen to the mortgage interest deduction in 2011 and beyond.

    Found one line in your article that is no longer true. Schedule L was good for 2009, but is not available for 2010.

    As for me, even if the mortgage interest deduction goes away, I’ll still itemize. I have enough other deductions to put me over the top.

  8. Fresno Jewell says:

    A number of you have pointed out that home ownership has the intrinsic value of a roof over your head and that homes appreciate in value. For at least the next 10 years there is no guarantee, or even indication, that homes will appreciate in value. In the meantime, a storm blew down my backyard fence which I now have to replace at a cost of about 15,000. My home needs electrical updating but since it’s underwater I can’t even get an equity loan for the work. In 15 or 20 years I’ll need a roof. Eventually a new water heater. Double paned windows, a new garage door, etc. etc. A home can be a great thing for some, it’s not a great thing for A LOT of people. Don’t believe the hype.

  9. robert says:

    you sir are an idiot. ( guy who wrote this)
    So after thirty years do I get to keep my apartment. Idiot, And eventually when my interest is low enough I can take the standard deduction on the flip side so its a win win.

  10. Anonymous says:

    Is the % on my mortg.payment in 2011 able to be written-off,if itemizing,in 2012??

  11. sally says:

    Funny that so many of the comments on here are slamming the author about rent vs. buy. I am in a position to either pay off my mortgage or keep it and found the article very informative. The author is simply stating the benefits of having no mortgage and no tax benefits, rather than a mortgage and a tax-break. He’s not getting into rent vs. buy, and he clearly states that in the article. For all of you who have said he has no brain, shame on you. I am thankful for the information.

  12. James S says:

    I am going to take it one more step further. Let’s say you do pay. off the home after 30 years. (Which I doubt, because average home owner stay is 5 years)But, let’s say you do, before slamming the author, you really have too look at your overall interest paid to overall deduction and its respective return. Let’s say Mark is right with appreciation value. We will assume average loan rate at 6% for $100K home. It appreciates at 3.5% to be conservative. The home is worth around $285K, so $185K in equity. Now we look at interst paid, which is roughly $115K. Your true equity gain is around $70K. So, for 30 years you had a return of investment of 70%. Now if you include maintenance, updates and tax deduction (maybe return) you may be in the black at around 25% at best. Or, in the red by -25%. If you look at it yes renting maybe throwing money away, but if you are able too live within your means and save money that is thrown away at interest you would come ahead in the long run and actually do better overall. Amortization is an archaic method, but we us it cause it is the only method banks use. The other loan methods are even worse. And, yes the author is more right than you know. Ow much is your home worth now? How many are even still in there home? How much did your home depreciate and how long before you make the value back that was lost? Some food for thought. DemAlo, LLC will be online soon

  13. Duke Ganote says:

    I concur with you and James S. “Once upon a time – just one or two generations ago – folks lived in their homes 15 or 20 years, or more… Today, the typical homeowner sells his or her home every five to seven years and the average individual will move 11.7 times during his or her lifetime.” True for me! And I’m renting because I refuse to sign a 30-year mortgage with one big corporation (the bank) when the other big corporate (my employer) feels perfectly free to let me go with 2-weeks notice. Am I the only one who wonders why “the little guy” is being pulled in a tug-of-war between two financial elephants?

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