Mortgage Interest
How many times have you heard a person or accountant say “don’t pay off your house, you need the writeoff”? Too many if you ask me. Here’s what I figured out and my accountant shook his head in disbelief when confronted with it.
Let’s use the following parameters:
- 100,000 annual income
- 27% effective tax bracket
- $16,000 in annual interest income.
By paying $16,000 in mortgage interest, you receive a $16,000 deduction. Simple enough. By taking this deduction, you actually save 27% of the $16k or $4320.
- Pay $16,000 in interest
- Take $16,000 deduction
- Save $4320 in taxes
Now let’s get this straight: Why the hell would anyone pay $16,000 to save $4320? You have lost $11680 just to get a $4320 deduction. Who perpetrated this fraud? It has to be the bankers. The same people who used to work until 3pm while you and I couldn’t leave our desks until 5pm when the bell rang. The one caveat here is that a $16,000 deduction could move you down a bracket, but even at that, you cannot break even unless you drop your effective tax rate 12% with a $16,000 deduction… I don’t believe this is possible unless you have a total of 71,000 in deductions on your $100,000 income.
If you have the ability to pay off your mortgage or not take one to begin with, why would you take a loss just to have a deduction???
Updated 5-29-07: Another scenario…
Let’s say you have $200,000 in mortgage at 6% and inherit $200,000 from your late uncle. Should you pay off the mortgage or put the cash in the bank?
Facts on the mortgage:
- The mortgage payment on a 30 year, $200,000 note at 6% is $1199.10 monthly (14389.20 annually).
- This provides a $14389.20 deduction your tax return for mortgage interest. The net savings is 27% of this number or $3885.08. Thus, the true cost of the money is $10,504.17.
Facts on the cash:
- $200,000 in a taxable CD earning 5% annually will earn you $10,000 annually in interest.
- The tax on this interest is 27% of the $10,000 or $2700, netting you $7300.
- HOWEVER, if you leave the cash to compound and pay the taxes out of pocket, this number will compound earning you a bit more each year.
Let’s consider the after-tax outcome of the above scenario:
$10,504.17 paid in mortgage interest
$7200 earned in interest on the $200,000.
Net cost to hold onto $200,000 in cash: $3304.17 or just about $275 per month.
What does all this mean? Your net mortgage cost is $275 per month, plus you have $200,000 in the bank! So when friends ask what your mortgage is monthly- the answer of course is $1199, but the reality is you have $200,000 in cash and make a net payment of $275 per month after realizing the interest on your money. Not too shabby. This is why the rich get richer.