Two questions left over from a recent chat got me thinking again about people’s fixation with the home-mortgage deduction.
Understandably, around tax time, people wonder if they’re getting all the deductions and credits they are entitled to. One of the most coveted tax breaks is on mortgage interest. So revered is this deduction that some folks who have the money to pay off their mortgages struggle over whether it makes sense to be debt-free. Here’s an example:
Q: I have enough money in savings to pay off my mortgage in full and still have a cushion for emergencies. The money in the savings account earns far less than the interest rate on the mortgage. People are telling me that paying off the mortgage will negatively affect my taxes since I will no longer have that deduction. But it seems to me that I only get a benefit of a portion of the money I pay out for the interest. I can live within my means without the mortgage payment, and I do not live large (no cable, no cellphone, etc.), but I can’t with it. It is important to me to max out my retirement savings/401(k), and that takes up a chunk of my paycheck. By the way, I’m single with no kids and in my 50s. What do you think?
Singletary: I know I’ll get letters from people who will disagree with me, but I say go for being debt-free — with a caveat.
If you itemize your tax return, you can usually deduct the interest you pay on a mortgage for your main home. The mortgage-interest deduction is different from a tax credit, a distinction that is sometimes lost on people trumpeting the tax break as a key reason to get a home or keep a mortgage. A tax credit reduces dollar-for-dollar the taxes you owe. A deduction eliminates only a percentage of the tax. If you don’t have a mortgage, you may pay more in taxes but not as much as you would have to pay in annual interest on the home loan, especially in the beginning years. You are right on the money to appreciate how illogical it is to keep a mortgage just for the tax break.
Because of the mortgage-interest deduction, many people are enticed into buying a home before they are ready. Yes, the deduction is a nice bonus. But it shouldn’t be the primary reason to get a home or to hold on to the loan if you can afford to pay it off early. By the way, many people don’t even take the deduction. “Close to half of homeowners with mortgages — most of them middle- and lower-income families — receive no benefit from the deduction,” writes the Center on Budget and Policy Priorities.
Here’s my caveat about paying off your mortgage. Be careful about getting rid of your savings in the current economy. Really think about whether you are vulnerable to losing your job, because if it takes you a long time to find employment, or you can’t work because of health reasons, you could easily go through your emergency fund. I don’t suggest you clean out your savings or sell all your investments to pay off your mortgage. You don’t want to be house rich and cash poor, meaning all your money is locked into the equity in your home — equity, I might add, that you can tap only by borrowing on your home or selling it.
But since you have a good emergency fund and retirement savings, and you can still pay off your mortgage with money outside those two pots, I would do it.
I often ask people this question: If you had a home that was paid off, would you take out a loan just so you could deduct the interest?
I hope you would say, “Absolutely not, that’s crazy.”
Q: My mother is turning 57 and is thinking about buying a house. She’s been renting for more than eight years, and from what I can tell the costs really add up. I think that it’s a good — and financially savvy — move tax-wise. I still think it’s a good investment and probably cheaper than continuing to rent for years down the road. What do you think?
Singletary: The tax advantage of buying a home shouldn’t be front and center when considering if it’s prudent to buy a home, whether you’re 27 or 57. In this case, your mother should factor in when she wants to retire and whether her retirement income can handle a mortgage. She might qualify for a mortgage with her current income, but she’s nearing the typical retirement years. She needs to ask herself a lot of other questions and make sure she can afford a mortgage based not just on the monthly payment. There are a lot of other costs and issues associated with homeownership.
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