The Myth of the Tax Deduction

Most of the time, when I talk about the implications of various debt repayment options on The Simple Dollar, I utterly ignore tax deductions.

This is not an oversight. Usually, it just makes a situation needlessly more complicated and takes the “simple” out of The Simple Dollar.

As is often the case, astute readers email me about this. John, for instance:

Your advice about ordering debts is really way out of line. You should pay off your home mortgage last so you can take advantage of the tax deduction.

Yes, tax deductions can be useful in some situations. Most of the time, though, they’re not much of a help and if you overvalue them, they’ll end up costing you in the long run.

First of all, most people don’t do deductions at all. 70% of tax filers simply use 1040EZ or 1040A for their tax returns, which means that they’re simply taking the standard deduction on their taxes.

If you’re doing that – and 70% of you are – then you’re not claiming a tax deduction for your mortgage or for a lot of other things. The tax implications of whether to pay your mortgage off first or another debt off first means nothing at all.

Beyond that, some of the 30% who do file the full 1040 do so for self-employment reasons and still claim the standard deduction, putting them in that group that is unaffected by deductions.

In a nutshell, if you take the standard deduction, you’re not counting your home mortgage as a deduction, and most Americans are taking the standard deduction.

Second, even if you do claim the deduction, it’s not as enormous as it’s often made out to be. Let’s look at the projected income tax brackets for 2010 and also assume that we’re talking about the average American family, bringing in $66,000 this year with two adults and two children in the household.

This income level puts that family in the 15% tax bracket. This means that if the family were to file long form and itemize their deductions, they would only deduct 15% of their annual mortgage interest from their taxes. In other words, the effective interest rate on their mortgage drops by only 15% when you take this into consideration. A 6% mortgage effectively becomes a 5.1% mortgage, in other words.

But it’s even worse than that.

To actually get that full 15%, you have to actually have other itemized claims that add up to more than the standard deduction for your family. The standard deduction for that family is $11,400. So, to get the full value of that 15%, a family filing with itemized deductions has to top $11,400 in deductions before including their home mortgage at all.

Let me show you what I mean. A couple filing jointly has a standard deduction of $11,400. They have $3,000 in various deductions and $10,000 in mortgage interest, so they’re going to file long form and itemize.

In the end, though, they’re only deducting $1,600 more than they would have with the standard deduction ($13,000 vs. $11,400). Even if you’re generous and say all of that money came from the mortgage, that’s still only a small deduction. If they’re in the 15% tax bracket mentioned above, they’re only saving $240 by filing long form. That’s the equivalent of dropping their 6% mortgage rate down to only 5.856%.

Here’s the truth. For almost all families, cash flow is much more of a day-to-day concern than tax deductions. It’s much more important that you have a low monthly debt load than it is to maximize your tax saving. With a high monthly debt load, you run the risk of going into more debt because of emergencies, and even a little bit of consumer debt taken on to handle those emergencies can quickly devour your “savings” from your deductions (and a lot more).

So, unless you’re very well off and have a strong monthly income, worrying about tax deductions and their impact on your day-to-day life is a bit of a moot point. It doesn’t save you all that much even if you do everything perfectly, and if doing everything “perfectly” means having a lot of monthly debt payments, you’re introducing a lot of risk into your life for relatively little reward.

Of course, credit card and mortgage marketers prefer that you’re in the latter situation. The more debt you’re in that you can handle and keep making the payments, the better off those big banks are because they’re just sitting back and collecting the interest off of you. Thus, they’ll talk up the tax advantages of various debts as much as they can, trying to make them sound like the greatest thing in the world.

You’re far better off having a small debt load and perhaps missing a deduction or two than having a high debt load and getting those deductions. The latter situation puts your whole financial house at risk because if an emergency occurs, you’ll have a very hard time meeting the monthly bills.

If you have a strong income, and are in a situation where you’re claiming lots of deductions anyway, it does become a factor, but if you’re in that situation, you’re in a very lucky and rather small minority of the American public.

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  1. Adam says:

    I totally agree with this. There is some benefit to mortgage debt over non mortgage debt, but it’s still debt. No sense paying 10 dollars to save 2. We’ve been over the standard deduction ever since we got married though, even before we bought a house.

  2. Joanna says:

    Agreed! I can never understand why people put so much emphasis on the tax deduction while ignoring the fact that the deduction is the result of money out the door. At the end of the day, even with the deduction, you’ve still negatively impacted your cash flow. But there’s a weird tendency to look only at the deduction while ignoring the interest cost.

  3. Jon says:

    I wish more people knew the truth about deductions, especially when it comes to mortgage interest. I have had friends tell me for years the benefits of owning a house because you get the deduction. They don’t understand at all. I think that those married friends understand even less how much interest it takes to even qualify to itemize. My entire mortgage payment doesn’t even come close to $11,400 per year, let alone the interest alone.

  4. Brent says:

    Agreed. I have challenged people on this before after the whole do not pay your home off early line of argument. After looking at their taxes sure enough, standard deduction.

  5. Texas Wahoo says:

    For those people who live in income tax states, they will likely reach the standard deduction much sooner.

  6. Stacey says:

    Agreed! And why would I want to spend $1,000 in interest payments to save $150 in deductions (or even $250 for the 25% bracket)? Some people just don’t understand our tax system.

  7. Sara says:

    I think that while this applied to a lot of people (over 70% of filers), it does make a difference in my situation. I usually have about $8000 worth of charitable contributions, that did me no good tax-wise before I bought a house. As I live on the East Coast (think high COLA and expensive houses), I paid about $12000 in mortgage interest last year – enough so that yes, that mortgage deduction is worth a LOT more to me than the example. I can now itemize almost twice the standard deduction.

    I do realize that the mortgage interest will go down as the years go on, and will plan for this. But I also realize that I am exactly the target audience for “not paying the mortgage off early – you’ll lose the tax deduction” even if over 70% of the rest of the country isn’t. That’s the PERSONAL part of Personal Finance.

  8. Crystal says:

    Our standard deduction is way higher than if we itemized. We “only” pay about $2500-$3000 a year in mortgage interest…I rather have no mortgage and no deduction than a big mortgage and a big deduction. :-)

  9. A says:

    wow. didn’t realize that few people itemized. I guess growing up in a family that did, and being one who gives enough to charity on a yearly basis, I just assumed that almost anyone with a mortgage payment would have enough to qualify to deduct (then again, I also realize I am unusual to have bought a house at age 24 as a single woman, and unusual to have reached the age of 28 without ever having any kind of debt beyond said mortgage)

  10. frugalrandy says:

    Thank you for writing about this! So many people I’ve talked to think they get some kind of tax credit by having a mortgage! Now I can just point them to this article instead of wasting my breath trying to explain it. And the comments so far are just as valuable as the article.

  11. Johanna says:

    Good point about standard versus itemized deductions. It amazes me, sometimes, how clueless people can be about the taxes that they themselves are paying (see also: tax brackets).

    But I’m a bit confused about what’s actually being advocated in this post. John’s letter references the order in which you pay off debts. Then you talk about cash flow and emergencies, and then marketers of credit cards (how are they relevant – they’re not tax deductible at all) and mortgages. Are you looking at the choice between getting an expensive house versus an inexpensive house? paying off the mortgage before other debts versus after? paying extra on your mortgage versus not?

    Also: I don’t have a mortgage at all, and I itemize deductions. State and local income taxes plus charitable contributions do it for me. In my high-tax and high-cost-of-living area, I don’t think my situation’s that unusual.

  12. kimberly says:

    I am so happy to see this! I completely agree, and I wish that this information was considered more thoroughly.

  13. Brian says:

    As you say, it does depend on your other deductions. I donate > 12% of my income. So that usually means itemizing deductions is well worth it for me.

    The fact still remains: mortgage interest is money that you are already paying out…. I agree with Crystal, no mortgage and no deduction is the way to go.

  14. wanzman says:

    I think it is wise to pay the mortgage off last, but not becuase of the tax deduction.

    For most people, the mortgage is probably their largest debt (hopefully). So it’s wiser to pay smaller debts off first to free up more cash flow in case of emergencies, such as a job loss. It doesn’t do any good to have your mortgage 99% paid off, because no matter what, next month’s payment will still be due.

    Actually, I’d rather have my house 100% mortgaged versus 5% mortgaged. If you have a ton of equity, and fall be hind on payments, there is no risk to the bank. They can just foreclose, sell the property, and get repaid. But if you owe a ton of money on the house, the bank is more likely to take a loss in the case of foreclosure. So, in this case, they will be more likely to work with you to find a better solution.

  15. Brian says:

    Another thing to consider is that the standard deduction is FREE money (i.e., you don’t have to spend any money to get it) while itemizing means you actually SPENT the amount of money you’re deducting.

  16. Ruth says:

    Ditto to Johanna’s comment – the standard deduction is intended to approximate the usual amount one would deduct by itemizing and therefore make tax filing simpler. Depending on what state you live in and your income level, your base-level itemized deductions may be better than the standard deduction. In my high tax, high income area, I come out ahead by itemizing my deductions – and the ONLY things on my itemized list are state income taxes and vehicle registration fees.

  17. Brent says:

    To help people out, usually people claim that investing the money, or even worse, just spending it on the house, will be a better use of the money than paying it off. They claim its for the deduction. I’ve also heard from MANY real estate agents that buying is better because myth 1. you throw away rent, but mortgages build equity. 2. the interest is tax deductible 3. the market is primed to rebound or keep climbing.
    Your interest deduction on the mortgage should be small. And it only helps to its full extent when you ALREADY itemize deductions.

    I myself just bought a house and still took the standard. (I checked to see which was higher). Mortgages are not automatically good deals, just like everything else.

  18. Nate says:

    Couple points: 1.I have student loans at 4% which is tax deductible without having to itemize…and yes I realize that really just discounts it to maybe 3.5%. So for me, student loans is by far my least expensive debt and I’d pay the last cent off my mortgage than the first cent off the student loan.
    2.Strange as wanzman sounds, it makes sense in terms of risk. Won’t matter how much home equity you have if something happens in your life and you can’t make that payment. So if you want to pay off the mortgage early, to protect yourself it makes sense to sock that money away in bonds that will about match the interest and pay it off in one lump once you’ve saved enough. When signing my mortgage papers when I asked the banker if I started paying ahead if that could be used as pre-payment money if I had to miss a payment every once in a while. They said ‘no way’ so I knew that I couldn’t even START paying it off early unless I had a substantial emergency fund. At 5% interest to save by paying off early I’d be MUCH safer keeping control of that money. Imagine paying $200/month extra for 3 years thinking you are making headway financially, then losing your job… Having that money in the bank to help make payments to KEEP your house would be a lot better than the bank just saying ‘thank you for the extra $3600′ when they foreclose. So much for that $250 in interest savings by paying early!

  19. Tara C says:

    I don’t have a mortgage like one of the readers above (house is paid for) and I itemize as well. I live in a high state tax area.

  20. Eric says:

    This also really depends on the state you’re living in. Since you can deduct state income tax paid, if you live in a high income tax state, where personal income taxes can top 9 or 10%, then it may make sense to itemize, and the mortgage deduction can make a bigger difference.

  21. Ellen says:

    I agree – the tax deduction argument never made much sense to me either. I’ve been filing taxes for almost 40 years now & have never had enough deductible expenses (mortgage, health costs, etc.) to make it worth itemizing.

  22. Alexis says:

    I agree with both sides. But since we have purchased our rental home, thats really the only time itemizing was a perk for us. Everything is a factor…thanks for the article!

  23. Itemizing deductions seems to only pay off in more expensive parts of the country, as mortgages and salaries are larger. And don’t forget, you can itemize property taxes, too. In NJ, some folks’ property taxes ALONE are more than the standard deduction — and I’m talking about middle-class neighborhoods! We bought a home, and we realize that itemizing only brings a portion of our money back to us. But if it’s more than the standard deduction, it’s worth itemizing to get it “refunded.”

  24. Doug says:

    This is actually one of my standard questions to determine if someone has half a brain. (“Why should I keep my mortgage?”)

    Usually, the “tax deduction” excuse is given, which leads me to my second question:
    “Why would you pay $10000 to a bank in order to not pay the government $2500?”

    I have yet to get a solid answer from a “financial expert.”

  25. George says:

    Nobody mentioned how the standard deduction increases each year while your deductible mortgage interest decreases, thus if you have a small mortgage, you’ll likely be better off taking the standard deduction after about 5 years unless you have other deductions.

    We (myself + spouse) have a mortgage and we itemize even with only one income (mine). Between Oregon income tax, property tax, and the mortage, we get to deduct 70% more than the standard deduction.

    If your mortgage is low (ours is 3.85%) and your investment return is significantly higher (think of bond funds yielding 6.5%-7% as a relatively safe investment), then paying off the mortgage ahead of schedule is leaving money on the table. Yes there is risk in such schemes, but at least there’s no shortage of liquidity.

  26. Troy says:

    You don’t keep a mortgage. You GIVE a mortgage. You get, or keep, a loan in exchange for a mortgage on your property. The mortgage is what the bank owns…not you.

    Many are asking the wrong question. Correlating paying $10K to save $2500 is like asking someone why they just spent money on a depreciating asset. We spend money on depreciating assets every day.

    The reason is the need. People need transportation. Food. Clothing. And people need housing.

    People buy a house for shelter. The tax deduction is a benefit, not a reason. The fact they pay substantialy more interest on a substantially nicer or more expensive house than most doesn’t change the reason, only the degree.

    Depending on the actual interest rate of the loan, the tax bracket, many of those who have the ability to pay off the mortgage do not for a variety of reasons. Risk, arbitrage, liqudity etc.

    And many people have itemized deductions that are many times over the standard deduction. Usually successful people with a bit more than half a brain.

    There is a reason for the deduction, and a reason why it benefits only a few. But for those few, it is a big benefit.

  27. Mike says:

    Another reason not to focus on the tax deduction is not everybody can get it. In Canada mortgage interest isn’t tax deductible for a primary residence. I think most countries (besides the USA) are the same. Debt/mortgage advice based on this would be mostly useless (I realize this may only be a small part of your readership).

  28. Susan says:

    I am trying to convince my husband to pay down the mortage. However, even though he can see that it doesn’t make much sense from a deduction standpoint for the interest…he says that it does matter then he deducts the ‘costs’ of his side business (which resides in our basement). I am wanting him to take the side business from a sole proprietorship to either a ‘s’ corp or a LLC…will this change anything? Thanks-

  29. CB says:

    The tax deduction for the interest is factored in to determine “how much house one can afford,” that is, what monthly payment can be made. In countries that don’t have this interest deduction, housing costs per month are determined without the tax deduction for interest.

    This was before the latest scam in which no papers were required to purchase a house at any price. Of course, the house’s value was to go up rapidly and forever, even if one’s income stayed at the minimum wage. Who might be living in these exorbitant homes? I was told that the foreigners would buy them. Bottom line–There was money to be made in the fees.

  30. Anna says:

    Well, gee, I don’t think of myself as particularly rich, and the mortgage deduction is a significant improvement for me. (and I DO consult a very good financial advisor once a year to make sure it’s still the best bet, which is also, incidentally, deductible.)

    The mortgage is also my lowest-interest debt, which is another reason to pay it down last. (Despite good credit, I’m not eligible to refinance my student loans- also deductible BTW- and I have some credit card debt that I’m paying off.)

    Like so many other things, it just depends….on income, mortgage amount (probably higher for many of us here in CA, even those of us who still have positive home equity), family circumstances, and other financial priorities.

  31. I totally agree. I’ve never understood why people are so hesitant to pay off a mortgage. Once you quite paying all that interest, you’re WAY money ahead, even without the tax deduction.

    Of course, wanting to pay off a mortgage and being able to do it are two different things…we’re not in a position right now where we can swing it, but we hope to start chipping away at our mortgage with extra payments in the near future.

  32. Doug says:

    Troy (#16), while people do spend money on depreciating assets every day, it is a poor financial decision to finance depreciating assets. For example, a new car.

    I bought a book the other day. It is definitely a depreciating asset to you, but to me it was a fair trade. I did not finance the book.

    Now, as for liquidity: A paid off house is far more liquid than a house with a loan attached, since the mortgage must be satisfied in the second case.

    As for risk: A house without a loan attached poses no risk for the owner, while a house with a loan attached means there is risk that severe financial difficulties will result in that house being foreclosed on. A quick review of data shows that 100% of the houses that were foreclosed on by banks had mortgages.

    As for arbitrage: Well, that would be a discussion of risk, since borrowing money always entails risk, but a paid off house always results in a more stable life.

    The tax deduction was used by many “financial experts” in the days leading up the the Housing Crash as an excuse to finance vehicles with home equity loans. This resulted in people being upside down when the bubble popped. Do you know who wasn’t upside down? Those people who didn’t have mortgages.

    Actually, my wife and I made out pretty well. Found a nice house on a bit of land. We were able to save up a lot of money because we weren’t paying out a lot of money to a bank in the form of a mortgage. We have a mortgage now, and will pay it off early precisely because it does not (nor has it ever) made financial sense to spend $10k in interest to not pay the government $2500.

  33. Very very very good stuff.

    I have always been a proponent of itemizing, it is good to know that this is not a catch-all type thing that should be done to the exclusion of any other method.

    Sometimes, we think were being financially sharp, but when you dig deep, we are costing ourselves money in the end.

    Great insights.

  34. lmoot says:

    My mortgage is a balance of $62,000 at $345/month at 5.375%. Paying it off won’t make much of a dent in my monthly expenses (not like those with $1000+ mortgage, which, btw, not everyone has). It is cheap money, especially as inflation and income increases. I’m already paying almost half of what it would cost to rent my house (and that’s including mortgage, taxes, and insurance)so I’m already ahead. I say only rush to pay off the mortgage if 1)You have so much extra cash flow that you don’t know where to put it 2)You plan on actually being able to pay off the mortgage during the time you intend to have the house (otherwise what’s the point if you can’t live in it mortgage free–it’s not like the monthly payments go down has you pay it off.
    3)You will benefit greatly from not having the expense (mind is the size of a car payment, in light of all of my other bills there is no motivation for me to sacrifice hard (harder than I already am) so save a pittance of my monthly income/expenses.

  35. Bob says:

    Using Turbo Tax, my itemized deductions are better for me at this point. But, I would love to have my mortgage low enough to be a lesser deduction then the standard.

  36. J Smith says:

    Excellent Post!!

    Now if only my mother-in-law could understand this :P Seriously though, that was a nice summary of the “other” side of the coin on having a mortgage for tax purposes…thanks!

  37. Becky says:

    Thanks for this article! I live in a high-tax state (Maine) and keep track of everything I could itemize every year. And I have never beat the standard deduction yet.

    I think a lot of people believe the hype about tax-deductible mortgage interest because it *sounds* so smart. But when you actually run the numbers, it’s usually not a great deal.

    Children provide some tax advantages too, but I doubt anybody has a child in order to get the tax deduction!

  38. Thank God you finally wrote about this! Our friends think we are crazy when we tell them we will have our house paid off in the next few years (10yrs rather than 30yr).

  39. Erin says:

    lmoot – I’m in a similar situation, $58,000 mortgage, 5.25%, payment (with taxes and insurance) is $460 a month.

    BUT…I do want to pay off my mortgage early. For me it makes sense because my goal is to shift to part time work by the age of 50 (I’m currently 35). Having my home paid for and taking that expense off my back (even though it’s not alot) will definitely help me achieve my goal of ‘early retirement’ (my version).

    I’m thinking long term and have no plans to move, so the tax advantage, one, wouldn’t make a huge difference for me, and two, isn’t a major factor when I look at my long term goals. Having a paid off home puts me closer to that goal. :)

  40. Laura says:

    I agree with your conclusion but want to mention that the property taxes you pay on your home are also deductable on the schedule A, so there is a slight bump in savings there.

  41. John says:

    Very good article. Since purchasing a house have enough deductions to beat the standard deduction by a few thousand but i’m still working hard to pay off the mortgage early to avoid paying all that extra interest which dwarfs any tax deduction benefit. It always amazes me how many people don’t understand this.

    I’m also perplexed by how many people think purchasing a home is the best investment they can make. Unless your home is consistently appreciating in value more than your interest rate then you’re technically losing money. Then when you add home repairs and upgrades to keep your house current and in good shape the loss becomes even more. The only plus is after you pay off the mortgage you begin to reap the benefits of living “free” the longer you stay in that home. I’d be curious to get your thoughts on this.

    My other question is related to the last paragraph. You state:

    “If you have a strong income, and are in a situation where you’re claiming lots of deductions anyway, it does become a factor, but if you’re in that situation, you’re in a very lucky and rather small minority of the American public.”

    I’m one of the “lucky” people in that situation but I didn’t think I was in a small minority. Are there any good websites that show statistics that break down the american public in terms of financial situations?

  42. Rachel McTague says:

    Excellent blog post! One reason I often hear people giving for not paying off the mortgage is that the money one uses to make pre-payments could be used for investing in the stock market and the return will exceed the amount of mortgage interest saved (over the long term. This too is a fallacy because if I have a 4 and 7/8 percent interest rate on my mortgage (which we do), I would have to make a consistent 7.5 percent return (before tax) in the market to exceed in returns the interest paid out. This is unrealistic in today’s market, where many investments lose money and such a high rate of return in the market is not consistent.

  43. Kathryn says:

    I’ve itemized for many years and have almost always gotten tax refunds. That includes my mortgage interest as well as professional expenses like continuing education, memberships, insurance and so on. If I didn’t have the interest, it wouldn’t be worth it to itemize. I realize that as my mortgage interest becomes less and less, it won’t be worth it to itemize any longer. I prefer the chunk of money I get once a year via tax refunds because 1)it often goes to clearing debt 2)I know I wouldn’t save very much on my own through the year and I do have other automatic savings plans. I also don’t put myself in the category of having a lot of wealth or assets so that extra money in a lump sum comes in very handy.

  44. Erin says:

    Such a great and useful article. A lot of people seem to think that something being “deductible” means it is deducted from your taxes, rather than being deducted from your taxable income. It’s very confusing so an understandable mistake.

  45. Claudia says:

    Great post! I completely agree. So many people do not understand tax deductions> Now, if mortgage interest could be used as a tax credit, not paying off your mortgage sooner might make sense.

  46. Jesse says:

    Trent,
    Thanks for this post. It needs to be shouted from the rooftops. This type of deduction situation is very common — and not just with the mortgage deduction.
    Any time a taxpayer is only marginally better off with their itemized deductions than with the standard, they should look and front-loading the itemized deductions — otherwise they’re lost to the wind forever.
    For instance, you could give charitable contributions at the end of 2010 that you would have donated in 2011. Then, in 2011, you take the standard deduction. It can save people serious money when they’re on the cusp of the standard deduction as you described.
    During this last tax season, I put together a video crash course on taxes (and made an attempt to have it be entertaining, which is quite a feat). Your readers may glean some good info from it:

    http://taxes.youneedabudget.com/course/

    (The course is free).

  47. Dee says:

    I have this advice to the 70% folks. Do the math. I’ve been doing our taxes since 1977 (long before Turbo Tax) and was able to save a lot by deducting our mortgage interest and property taxes plus other stuff. After paying off the mortgage and low Prop 13 property taxes (lucky us), we now have to use the standard deduction. Of course, even though we contribute generously to charity, we cannot deduct those any more. If you use Turbo Tax, they will tell you which way is best for your situation.

  48. Becca says:

    I itemize, live in a high tax state, and am single so the standard deduction is lower. That said, I don’t keep my mortgage because there’s a tax deduction, I keep it because I can’t afford to pay it off yet. Still, it’s nice to have that deduction.

    As for cash flow, it’s pretty easy to figure out how much tax I will owe; I have nearly all the numbers the year before. I just adjust my withholding and voila, more cash flow. I know that some people like a big sum once a year but I prefer a slightly larger paycheck.

  49. Dave says:

    Good post, Trent. By the time you subtract the standard deduction, it isn’t worth having a mortgage. I agree with the other posters about cash flow. Obviously, you don’t want to pay off your house and have no money left over. Duh! But all things considered, if you have an emergency fund and a good cash flow, paying off your mortgage frees up hundreds of dollars a month in cash flow to add to retirement funds, or just to spend if you want on trips and life’s nicer things. I know this because I paid my mortgage off several years ago and had the nice dilemma of what to do with the extra $850 a month!

  50. laura k says:

    @Doug (#20)–I’m confused.

    You say “A quick review of data shows that 100% of the houses that were foreclosed on by banks had mortgages.” Maybe I’m missing something, but if foreclosure is something that is done to collect on a loan, how could a bank every foreclose on a house that does not have said loan (mortgage)?

    You also say “Do you know who wasn’t upside down? Those people who didn’t have mortgages.” Again, maybe I don’t see your point, but if being upside down means owing more on your mortgage than your house is worth, how can you possibly be upside down when you don’t owe anything on your house (ie, do not have a mortgage)?

  51. Jay says:

    I agree 100% about the deduction not being much of anything for solidly middle class people. I’m going to pay my mortgage off as soon as I can. However there is one way to partially get around the $11,400 Standard Deduction Requirement. Deduction Bunching, Bunch all of your variable deductions such as charitable donations (Tithe’s) etc. Into Every Other year. That way for example your total deductable items one year may be $18000 and the next year maybe $6,000 instead of $12,000 for both years.

  52. nadine says:

    laura k,

    Doug was being sarcastic to make a point.

  53. RE Ramcharan says:

    Even ignoring the tax deduction, there are still good reasons for paying off the home mortgage last. For most people, the home mortgage is the largest (in dollar amount) debt. Maybe it’s a tossup with the student loans, but it’s still much bigger than credit cards or car loans.
    Paying the smallest debts first, you get to feel good about making progress with reducing your overall debt burden, which makes it easier to keep going.

  54. J says:

    @laura k — your humor detection system is broken.

  55. laura k says:

    @ J (and nadine): Apparently so! I should stop letting work get in the way of my blog reading! ;)

  56. jim says:

    Laura, Doug’s point is that you can only lose your home to a bank via foreclosure or be upside down on a mortgage if you have a mortgage in the first place and if you don’t have a mortgage then you have no risk of either.

  57. sewingirl says:

    Thank you very much! I have been trying to tell friends this for years, and they always look at me like I’m demented. But they don’t actually LOOK at their “professionally prepared” returns to see how much $$$ they are duducting. We paid for 20+ years on our mortgage, and not one year was there any advantage for us to itemize, we always used the standard deduction. You have to do the math!

  58. George says:

    @Doug – “Now, as for liquidity: A paid off house is far more liquid than a house with a loan attached, since the mortgage must be satisfied in the second case.”

    Only true if the sale is a short sale without the mortgage being satisfied.

    Otherwise, a home with a mortgage and a home without a mortgage are equally illiquid… once a sale is prepared, it typically takes a 7-15 days to record the sale and deed and investigate the title, whereas sale of a security closes in 3 days and a CD closure is same-day.

  59. Connie says:

    We paid off our 30yr. mortgage in 7yrs. and saved over $150,000.00 in interest. No way our tax deduction could beat that. Plus the peace of mind of owning your home free and clear, is priceless.

  60. Doug says:

    laura k . . . glad I can help keep you on your toes. Didn’t mean to confuse you like that. :)

    George, a paid for house can have a buyer in a month, while someone who needs to satisfy a mortgage needs to wait until someone offers the appropriate amount. A friend of mine needs to meet her $200k loan balance, and has had her house on the market for close to two years. I’m sure she wishes she had a smaller loan.

    If you are relying on your house instead of a true emergency fund, you really need to get a better financial advisor.

  61. George says:

    @Doug – my emergency fund meets 2 years of expenses and I’m my own financial advisor. Why pay someone to screw up my finances when I can screw them up myself for free :-)

  62. I would rather have 50% of my net worth in house equity and 50% in stocks and bonds. Why? I don’t like having all my net worth in one asset. I may pay off my house early, but not at the expense of 401(k), IRA, emergency fund, and other savings.

    I do take the home mortgage deduction, but I live in a Seattle where house prices are higher than average and we have no kids, so our mortgage interest alone is more than our standard deduction.

  63. Jeremy says:

    Great Article.

    Cash flow is king and most families need to harness the power of cash flow. All tax deductions still represent money spent and as your article explains its never a one to one return.

    Tax deductions are a justification for getting things that you want. Take them if you have them, but don’t use them to justify a purchase.

    Tax deductions are a ruse. Tax cuts increase cash flow.

  64. Doug says:

    George- because you’re a kind-hearted fellow with a soft spot for hard-sell commission-based “brokers” whose mission in life is to make you . . . well . . . “broker?”

    C’mon, pretend you’re the government and waste some money . . .

    Sheesh, I gotta lay off the caffeine before bed.

  65. Brian says:

    I don’t think my situation is THAT unique, and yet there are several reasons why the author’s claim makes little sense to me, unless I’m missing something.

    1. Thinking of your mortgage as a debt. To me, this assumes you’re going to live in that house for the rest of your life. I’m 29, and this is a “starter house”. My mortgage isn’t really a debt, it’s an elected fixed expense, like my phone bill. I’m not renting because I wanted to live HERE, not in some rental. So I’m renting from the bank.

    2. Paying off the mortgage. Again, I’m not going to live here the rest of my life. And I still owe like $200,000. I’d have to put $10k against principle every year, for 20 years, to do that. If I had that kind of money, I’d live in a bigger house.

    3. The standard deduction being big enough, or bigger, than itemizing. I’m self-employed (and I have complicated K1s), so I pretty much have to itemize and file long-form. I use TurboTax, which will tell me after I itemize (but before I file) whether the standard deduction would be bigger. It never is, but I know TurboTax will confirm that. The advice in this article seems to encourage you to guess. Why? Just keep good financial records, itemize, and let the software or accountant figure out how to get you the biggest deduction.

    3. The diminishing return of the interest deduction (due to decreasing interest payments over time). But I’m only 4 years into the mortgage. Most of my friends are all in the same boat; they’ve been in their houses 5 years or less. So while it’s nice to keep in mind, it’s not really practical advice when you have a large balance remaining.

  66. Bret says:

    I had my financial planner give me this one a few years ago, and not sure how I feel about it.

    If your house is paid off, a huge portion of your net worth is invested in real estate. That’s not so bad over the very long term if you are diversified in many properties or in a REIT, but this is all in ONE HOUSE. All your eggs are in one basket. For most, the value of their house is probably 75-90% of their worth. At least with a mortgage, the bank owns some of the risk – not just you.

  67. George says:

    @Doug – Ever hear of a discount broker? They don’t recommend or hard-sell anything.

    Open your eyes and realize that there are people who are not “average” and are quite capable of peforming their own analysis.

  68. Brian says:

    A follow-up to my last comment:

    5. The author says that, in his example, you’d only get to deduct $240 extra. Okay, but that works out to $12/month, and blogs like this regularly advise to be micro-frugal. Why should I suddenly not care about $240?

    6. I’m not sure I understand what the author is actually advising. Assuming the outright payoff of my mortgage is neither financially feasible nor necessary (see earlier points about only being 4 years in, and not living here for the long haul), other than the few extra hours spent filing my return, what is the real downside to filing long-form and taking the deductions? Taking the standard deduction probably won’t SAVE me money, at best it’ll come out even and save me some time, but it’s not like there’s extra money I could use to buy down points or something.

    I’m pretty sure I’m missing something here, and I’ll probably feel pretty silly when I find out what it is. I’m still kind of a novice :)

  69. Tim says:

    Great, great post. I’ve had to talk way too many of my friends out of buying real estate “because of the tax deduction.”

    On top of all of your reasons about itemizing deductions, people underestimate the true costs of home ownership (maintenance, interest payments, etc), and they don’t realize that owning a home is often more of a liability than an asset, even AFTER the deduction.

    Might be an interesting topic for a follow-up?

  70. Joe M says:

    Good post. I do itemize but am in the process of paying off my mortgage. For one, I’ve never understood why it makes sense to give the bank a dollar in interest to avoid giving the government a quarter in taxes.

    I think I will rest easier having the home paid for. I’m not sure how to put a dollar figure on that, but it will bring me some mental peace. Also, once the mortgage is paid my emergency fund will last that much longer if needed.

  71. Doug says:

    George, I was using sarcasm again.

    I am very aware that there are plenty of people who are capable of performing their own analyses. I’m also aware that there are people who think that buying $30 in lottery tickets every week is the way they’re gonna retire.

    Continue on with your finances; I’m sure you’ll do fine. I’m going to continue to pay off my mortgage early.

  72. Tom says:

    I totally agree with this article. Keeping a mortgage solely for the deduction usually does not make sense.

    Some have mentioned using the money for investment, which is an argument I can also agree with…in special circumstances, only. If your investments grow at the average 8-10%, you are still paying income taxes on that percentage, bringing the net down somewhere nearer to the 6% level you are paying for your mortgage.

    When the market was in the dumps, I paid down a significant portion of my mortgage, seeing it as making 6% on my investment, rather than losing 25%-80% on the market. When the market was near the bottom, I switched to smaller (but still accelerated) mortgage payments and invested the rest – which returned 60-80% in a year.

    There is no risk in paying off your mortgage, but there are times where it is beneficial to take on greater risk for the greater reward investment can give.

  73. Fred says:

    While I agree with what was said, isn’t John’s point that you quoted still valid? Most people can’t afford to just pay off their mortgage, so when it comes to paying off debt, the mortgage should be last. Pay off credit cards and other non-deductible loans first.

    The liquid argument can also be valid. If people need money, selling their home is usually a last resort. If you saved a large amount of money and can invest it in something that gets an equivalent return (accounting for the lower equivalent mortgage interest rate the deduction allows) it makes sense to NOT pay off your mortgage.

  74. Helena says:

    I was amazed that 66,000 is the average family income. We (family of six) live on half that with 4 homeschooled children and our house is paid of in a couple of years. Presently we have four teenagers that eat alot.

  75. Bill says:

    The tax arguement is pointless. You should [normally] pay off your mortage last because most of the time it is the debt with the lowest interest rate…end of story. Now if that is the only debt you are sitting on, and doing so only becasue of the tax deduction then you need to wake up.

    If you have debt that is at a lower rate then your mortage, either you have a high rate mortage [I am sorry for you] or some awesome credit cards [tell us what bank you are getting <5% credit from please!!!!]….

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