Please explain why paying off early/not having a mortgage payment outweighs the tax benefits of having a mortgage. I know it is true, but have a hard time explaining it to others. -Susan
Wow, talk about slaying a “sacred cow” here! The so-called “mortgage deduction” is one of the most-oft-given reasons people have given to us as to why it was unwise for us to buy a house with cash.
It is interesting that, recently, the Deficit Reduction Commission came out with a list of actions it would recommend taking to help reduce the national deficit to get the country back on sound financial footing. One of the most controversial recommendations they came up with was doing away with the mortgage deduction. The import of this would be to throw out one of the main justifications folks use to keep themselves saddled with a monthly mortgage on their personal residence.
The thing is, most people don’t use the deduction because only a fraction of Americans actually take itemized deductions on their federal income tax returns.
To illustrate how the deduction supposedly works (please correct me if I am wrong), let’s say you make $68,000 per year and have made enough charitable gifts, etc. to justify itemizing the deductions on your income tax return, as opposed to taking the standard deduction. In addition, assume a monthly mortgage payment of about $650 (a figure which is below the national average, according to the National Association of Realtors) on a $120,000 30-year loan at 5% interest. This would be the case if you purchased a house for $150,000 and put 20% down.
With these assumptions, according to the calculator I used, first year interest payments would be just shy of $6000, with total monthly payments being just north of $7700 per year. The tax deduction would be right around $1750 the first year, according to the calculator, with an average over the life of the loan of approximately $1100. (Bear in mind this is quick and dirty math and the actual figures may vary.)
If I had a mortgage and enough deductions to itemize and take the mortgage deduction, I would definitely take it. It is a no-brainer not to.
However, if I were mortgage-free and considering one, I think in the short run I would rather pay less in rent than what the mortgage payment would be, save the difference, and let the property management company take the hit on maintenance and the owner on property taxes, saving those costs as well, and take the standard deduction until in a position where I could put a nice down payment on a home (by “nice” I mean non-conventional, e.g., 20%+ — think outside the box and challenge yourself!).
But that is me and assumes the standard deduction would be more than any itemized deductions. If it looked like I would not be in a position to make that down payment in five years or so, I would take the mortgage and pay it off as quickly as possible. Clear as mud?
As you can see, I don’t think I would use the deduction alone as justification to get a home loan, there would need to be other factors present, such as the expected length of time of saving, and whether we were planning on staying in one place for more than two or three years to allow equity to build.
Adding to the hesitancy to use the deduction as the only deciding factor for getting a loan is the possibility that the same could be repealed as a cost-savings measure to reduce the deficit. I doubt the repeal would ever happen, and there would be immense political fallout if it were, nonetheless there would have to be more than just the deduction benefit to justify taking out a mortgage just the same.
That said, you will definitely want to talk to your tax professional to see what the tax benefit would be in your case, as there can be more that goes into figuring the deduction than just rate, loan value, interest payment, etc., (e.g., points paid to lower the interest rate, loan origination fees, and other closing costs).
Jesse Paine is a licensed attorney who owns his own law firm. He’s married to Crystal and is the numbers nerd of the MoneySavingMom.com team! If you have a question you’d like him to answer in a future column, you can submit it here.
The content of this column intended for informational use only and is not to be construed as providing legal, investing, accounting, or other professional advice. Your situation is factually specific and you should accordingly seek qualified professional counsel concerning your specific legal, investing or accounting needs.
Now if there was only a way to be tax free on your property …….. Sigh…….. Living here in the North East where property taxes are crazy…..my mortgage is very low and almost paid for……my property taxes far exceed my mortgage payment …….. $16,700 a year for a 100 x 100 lot on which my modest ranch house sits. Nuts!
This discussion has been really helpful to my understanding of how the mortgage and tax systems work. Thanks everyone!
I praise God that my husband and I have never been in debt. We’re renting and getting oh, so close to buying our first home–with cash, after 3 1/2 years of saving. It’ll be a modest start, to be sure, and we’re assuming we’ll get a fixer-upper, but we don’t want to forfeit the freedom we have being debt-free: freedom to give, freedom from worrying about losing our home, knowing that we are not slaves to any lender, etc. And we’re really excited about the potential for growth as we finally own a home and no longer pay rent…and save some more. Baby steps.
The only way I’ve seen it figured that you can come out ahead (financially speaking) by taking out a mortgage (vs. renting and saving) is if you get a low interest rate and pay off your loan in about 5 years. Otherwise you are going to start losing so much money on interest that renting for 5 years would have saved you a bundle. That’s what we found when we ran our numbers through a calculator, anyway. And that’s not taking into account the fact that as a renter you have no property tax, no expenses for the upkeep of your home, no money going into renovations or non-essential lawn care, etc. If you’re up in the air on the issue of rent and save vs. borrow, how can a tax deduction touch all that???
Erica @ Just Call Me Cheap says
Honestly, no matter what tax benefit I got from having a mortgage I would much rather have the security of knowing that I own my home. If anything were to happen and our income was cut at least we would know that we had a paid for house and a roof overt our heads.
We do have a mortgage now but I cannot wait until the day we own our home outright.
Keep in mind though that I am more of a “keep my cash hidden in my mattress” kind of girl than one to take risks (yes, I do keep my money in a bank but when my husband and I were saving up to move out of our parents’ homes and into into our first apartment we kept all of our money in a shoe box- it was very gratifying and motivating to be able to see and touch our savings!).
I needed this ONE HOUR after I read it today. We are just barely talking with a realtor and when I told him we’d like to pay the house off in 10 years and get a really small house he told me it was a bad idea thanks to the tax deduction. Ha ha THANK YOU SO MUCH for this!!! I knew the moment I read it that it was God giving me something I’d need today.
I didn’t buy a home just for the tax deduction, but it does help.
Sure, we could start paying down our home faster. But when you live in an area where your first home will easily cost $250k, it would take most people a very long time to come up with that kind of cash. Instead of putting our extra cash towards our home, we put it into our retirement. With a 4.5% mortgage rate and a 28% tax rate, let’s just do laymen’s math and say that we only pay 3.25% on our mortgage after the tax break.
So instead of paying down a mortgage that would take me a decade plus to pay off, we put money into our retirement accounts, which will average a lot better than a 4% return over the long haul (over the past 5 years, even including the big drop, I’m up about 8%).
Plus, in case of ridiculously bad emergency, I could tap my Roth to pay my mortgage. The mortgage company won’t care that I’ve put an extra $20k down on my home in the last two years – I still have to pay that payment every month or they’ll take the house from me.
Well, when I think of rent (and try to save for cash payment) or own, it was easy for our family. Of course, we currently get maybe 35K a year between the two of us, so saving after a $550 rent (for a 2br in a drug infested neighborhood) would be very difficult. However, our 87K home with 3br, full basement, and bonus room come in at $520 a month with property taxes included (which aren’t but 200 a year). Sure, we may pay more in intrest (only 4.375% however), but to raise our daughter in a house with decent school and no drug influence is priceless to us. Oh, and once we have a few other thing paid down (car and hospital bills from her birth (no intrest 😀 ) ) We will be making larger principle payments than rounding to the next $5. (those pennies do add up in intrest). The mortage deduction likely won’t come into play with us, but the home is certainly worth it to us.
I live in Texas-low home costs (less than 200k) and high property taxes. I think they are close to 6-7k a year so perhaps I overestimated the breakdown. I know we pay $1600 a month, maybe the mortgage itself closer to 1k?
I agree that the deduction is not as important as owning the house free and clear, BUT when we had a mortgage ( for about 12 years) rent would have been much more expensive because our mortgage payment were low. Since we built our own house, having a mortgage meant we had a finished house to live in rather than one half finished—My husband felt that the quality of life by living in a house that was not halfway done was worth a small mortgage. We have no debt now but it was worth it when the kids were growing up.
Wow! Talk about some low payments. Our property and school TAXES total $1000 per month! We plan to pay our house off as quickly as possible. However with a 15 year mortgage at 3.75% paying a little extra doesn’t give much traction. To be zoned to a half way decent school district in a large city costs $$$. We decided we would rather have a mortgage and tax deduction than spend big bucks on private schools for multiple children (if we could even find a way to pay that outrageous tuition). Living in the suburbs isn’t an option. We would never see Dad if he spent 2+ hours a day in the car on top of his 10-12 hour work day. It’s a price worth paying for us.
@TexasMom, You don’t have income taxes though, do you?
We do pay Fedral income tax. However, our state does not have an income tax. I do believe our sales tax is higher than most states though…
My husband and I put 50% down on our home. We could have paid cash for a home, but wouldn’t have been able to buy something in the area where we wanted to live -safe, good schools, etc. Our mortgage payment is still MUCH less than rent, and other than the mortgage, we are debt free.
My husband is itching to pay off our mortgage. We have enough money in savings to make a big dent in it, but I’m scared to have it “tied up” in our house just in case we have an “emergency” and need that money. Am I right to hold on to the cash or would it be better to be completely debt free?
@DJ, You could meet in the middle. Set aside a nice chunk as an emergency fund (6 months of expenses or so) and then put the rest towards the mortgage.
I’m also wondering if it’s better to put it in the 401K now since we can “buy low”.
These are very interesting comments. One thing I noticed is a lot of people are saying that they would keep $6,000 in interest payments made instead of getting a $1750 tax deduction. It isn’t that simple because you have to consider that if you don’t buy a house, you will have to rent one.
To compare monthly out-of-pocket expenses, compare the cost of rent & renters insurance vs the cost of mortgage (P&I), homeowners insurance, property taxes & maintenance expense. The difference is how much you can save by renting.
Then you have to look at how long you plan to stay in the house, expected amount of home appreciation (although not a lot of areas have to worry about that anymore), investment returns when you rent and put monthly savings into investments.
There are so many things to consider and many are variables for each circumstance. So it is truly something that needs to be looked at on an individual basis and decided based on your specific set of facts and even personal preference or “financial personality”. For example, if you historically are not a good “saver” then you probably would not be a good one to rent and “save” to pay cash for a home.
Here is a very simple answer to the “tax deduction” for a mortgage question. We have always had enough deductions to itemize and yet we still paid off our mortgage. Here’s why……our adjusted gross income put us either in the 15% or 25% tax braket. So if we paid say $8000 in mortgage interest for the year, $1200 to $2000 was deductable. So we were paying out $8000 to save $1200 or $2000. This means that we were paying out $1 to save between 15 cents and a quarter. I’ll pay the quarter in taxes and keep the 75 cents, thanks.
My husband and I were just talking about this last night!
What I always tell people is that I would rather send $1,000 a month to my favorite charity than send $1,000 a month to XXX Bank. It is the same tax benefit if you itemize.
When I put it like that, people usually think about it a few seconds, agree with the statement, and then are quiet. LOL
The Prudent Homemaker says
While I totally agree about paying off your mortgage or paying cash is possible, I was amazed at your $600 a month for a mortgage payment. I know you were using a small amount to prove an important point, but wow–you can’t even rent a one-bedroom apartment for that much here! $600 is what many in my neighorhood pay for one month’s electric bill in the summer!
@The Prudent Homemaker,
Funny, I was thinking the $650 sounded expensive! lol
Ours is $537. Sure, we qualify for a lot higher payment, but we just couldn’t stomach paying so much each month — even if we could supposedly ‘afford’ it according to the bank. Thankfully we live in the Midwest where housing isn’t outrageously priced. Some areas of the country $650 probably seems like a Godsend.
The Prudent Homemaker says
@Trixie, It really depends on where you live. This is why I also think it’s unreasonable to assume that people who make over $200,000 a year are rich; they could live in a place where the cost of housing is very high. A couple of years ago, my husband and I were looking online at houses for sale in the neighborhood where he grew up in the 1960’s and 1970’s . The houses were 1100-1300 square feet, built in the 1950’s and 1960’s, and they were going for over 1 million dollars each! (this was in Southern California). Even renting 15 years ago, 1 1/2 hours north of there, I couldn’t find a one-bedroom for under $1050 a month–and I couldn’t afford that!
I’m in Las Vegas now, and we have 6-7 months where we run the a/c (April through the end of October). It is 116º on average here in the summer (cooling down to 104º at midnight). For the last 4 years, the electric company here has raised rates every quarter! My sister-in-law pays well over $900 a month for her electric bill!
Your amount sounds amazing! What a blessing that would be!
Michele @ Saving Money In Real Life says
@Trixie, I live in the Washington, DC area. If you can find a one-bedroom for $1200 per month, you would be ecstatic! LOL!
Dana @ Groupon Girl says
@Michele @ Saving Money In Real Life,
I’m in a similar boat, Michele. We live in Charlottesville, just a couple hours south of DC. We live in a very modest house, and still, a $600/month mortgage- or even rent for that amount- is stunningly low to me!
@The Prudent Homemaker,
We recently moved from Seattle to Phoenix. The AC bill were shocking, but we bought a comparable house here for less than 1/2 the value of our Seattle house. (you are very lucky to find ANY house or condo in the greater Seattle area for less than $200K and that will be a very small fixer upper). Groceries are also very inexpensive here by comparison. And so far this winter we’ve used our furnace only 1 day. Our AC bill in July, Aug and Sept ran $300-$400 a month though (and we were really hot).
a good way to keep the deduction after paying off your home would be to take the amount that you were paying in interest every year & add more to charitable giving. Then you get the best of both worlds, you have your home paid for & you get to keep the deduction. Plus you get to decide where you want that money to go & it doesn’t just go to interest 🙂
Thank you Sarah! I am in the exact same position and wondering the same thing. We could pay for our house but we have a mortgage and leave our money invested instead. I just don’t see how enough money to buy a house invested over 30 years (or even 20 or 15 if you pay your mortgage off early) wouldn’t earn more than the 4.5% interest rate we have on our mortgage, even as it’s depleted over the years for mortgage payments. I’m sure I’m missing something, I’m far from an expert on these things!
@SaraR., Now I have a little insight on this being in the financial industry. If you are not earning enough intrest on your money to outweigh the intrest you are paying for your home, you could always consider a CD sercured loan. Typically (depending on the financial institution) you can enter your money into a CD and borrow against your own money. Because of the reduced risk to the finanical institution, you typically pay 1-1.5% more in intrest than you earn on your investment. Lets say your money is earning 2% in a CD, and you do this type of special financing. So your intrest rate on your mortage is now 3-3.5% … significantly less if your home has been financed for several years (unless you got in 2001 when rates were as low as 2% … wow) Now, when you get your 1099 for intrest income, it is offset by the amount of intrest paid on your loan. Intresting if you feel fustrated by the taxes on your investments. Just a thought, as I don’t actually sell any of these product, but I do know of them and their benefits.
One reason some ‘wealth builders’ will use to keep your mortgage is if your interest payment is lower than what your investment could make it may be financially beneficial to keep the mortgage. For example, if you have 100,000 sitting in the bank and they could invest it for you at 8% while you are only paying 4% for your house. In this scenario (very round numbers) you could make $8000 while only paying $4000 in interest which is then tax deductible.
In my opinion I’d prefer to pay off the house and live debt free, but that would be an example of why someone may want to keep the mortgage.
Everyone needs to decide what is best for them. My husband and I have a mortgage and are thankful we bought our house when we did. It’s value has increased significantly and we don’t pay that much more than we would in an apartment. I’m hoping to be mortgage free in five years and have that money to invest in retirement.
My DH always talks about this whenever I bring up whether we should pay more in principal each month in order to pay down our mortgage faster. He was a finance major and argues that whatever savings money we have should be invested in the stock market, not used to pay down our mortgage debt faster. He says we’d come out better in the long run because of compounded interest. (Note: we have a 15 yr mortgage with a very low interest rate from a recent refinancing and we were able to have a 20% down payment on our loan so we may be in a different boat than others).
But when you are unemployed and the stock market is down, a paid off house keeps a roof over your head until you find work again. Also, the spread between say a 4.5% interest rate on your interest rate and getting 12% in the market seems like you are making 8%, but don’t forget that you will pay capital gains taxes of 15% on that spread which will shrink the profit margin dramatically. Also, if risk is factored in the spread goes to nearly nothing. It is still smarter, long run and way less risky to have a paid off house.
Unless you are getting 100% (or more) of the interest paid in deducted, it saves you money in the long run NOT to have a mortgage. That being said, we do have a mortgage and do not look down on anyone that does, but would love to one day pay off the mortgage early if possible. Another thing to think about is let’s say your mortgage is $1000/month. If you don’t have a mortgage payment anymore, you now have $12,000 (-property taxes) to spend on something else in a year’s time. And your deduction would certainly be less than $12,000!
I think our deduction was somewhere around 1k or so?
We chose to purchase a home because we wanted a home and were tired of apartment living. We made the choice as to what was right for us, not for a deduction. We bought a home less than we can afford but still takes $$. Mortgage is around $800-900 but we pay an additional $800 in property taxes per MONTH.
I love, love , love our home and it would be very difficult to go back to an apartment with our child but sometimes part of me wishes it would be that easy again, paying $900 a month for rent and that’s it…
hopefully we’ll be able to stay here though. I think owning a home is just a personal decision and if I had the extra $$ I’d pay it off in a heartbeat!
@jennifer, Good heavens where do you live that your property taxes are more than $9000 a year? WOW! I though the property taxes on my Seattle house were high ($4200 a year and then another $1000 a year in home owners insurance) as opposed to the taxes on my Phoenix house (same size as Seattle) which are $1700 a year and $650 in home owners insurance.
@jennifer, I’m just a little intrested to ask … did you claim your homestead exemption for your property taxes? I understand that those can be high, but it seems like some of these figures are excessive and are not being claimed.
I’m not sure to be honest. one major splurge for us..we have a CPA. He figures all of it out. we always itemize and it works out. Our best advice when looking for a home actually came from him when he told us that the mortgage deduction would make very little change on our return since we already have significant deductions for our church tithe, student loan interest and various others. And..he was right. I noticed NO change in our amount owed other than the $7500 home credit we were able to get 2 yrs ago. dont agree with the politics behind this decision but it sure helped us!
Okay, here’s my question. We have enough $ in investments to pay off our house (due to an inheritance), but we still keep the mortgage. The way it was presented to us (by my father) is that as long as our interest rate on the investments and our interest on the mortgage are about the same, it’s a wash- but that it’s nice to have the cushion of available funds for emergencies (how much cushion is “enough” was never detailed) and that then all the capital isn’t tied up in the house, should we decide to move, for example. Are we foolish in this move? Obviously the Paines had the funds as well and could have invested in other funds instead of the house. We’re also in a position where we have NO extra money at the end of the month. My hubby gets $100 taken out per month for his retirement fund and that’s all we are saving at this point. I’d feel better having the monthly cushion (around $700) to start building, but it’d take a long time to build back the 120K at 700/mo. Any advice (from anyone!) would be appreciated. thanks 🙂
@Sarah, Are you planning on staying in your house? I’d love to be mortgage free, even at the cost of cashing in your inheritance. What peace of mind you’d have with no monthly mortage payment. You could have your EF back up in no time. You could also keep 3-6 months of expenses separate and put the rest to your mortgage. Then pay off the balance ASAP. What a feeling it must be to have your house paid off. I say go for it:)
shannon m says
I too would love to understand why some financial people will tell you you are better off investing that money because in 30 years you would be more ahead if you invested than if you had paid off a 30 year mortgage in 15……..
Rachel Adkins says
@Sarah, I would keep a years worth of expenses and throw the rest at the mortgage. I would love to be able to get rid of the mortgage and quit paying interest.
@Sarah, I agree with Rachel. I would keep a year’s worth of expenses and put all the rest on the mortgage. Rates are fantastically low right now so after you put all that extra on your mortgage, you can refinance for a significantly lower monthly mortgage payment. Then you can either take the money you will then have extra at the end of the month (since you say you don’t have any now) and start putting it back into investments, or put it towards your principal to pay what’s left of your mortgage off sooner.
Either way you have a whole year’s expenses as a safety net, plus the flexibility gained with lower monthly payments.
@Sarah, I think your father is right that mathematically it is a wash if the interest rates remain the same. So, keep an eye on the interest rates and adjust your plan if things change. What he may not be considering is risk. With any debt comes risk, but some investments are unpredictable too, so you have to decide which kind of risk you’re more comfortable with. As far as retirement savings— it sounds like that inheritance IS your retirement savings, so don’t feel like you have nothing. Our interest rate on our mortgage is really low so I’d have a hard time paying it off if I had the cash sitting around and could invest it elsewhere…but I might.
Like others have said, you should not use your emergency fund to pay down your mortgage. You should leave whatever the equivalent of about 6 months of living expenses would be in an easily accessible form in case you need it. Not knowing your particular investments, it would be hard to imagine that anything your invested in is earning better interest than what I assume is a slightly higher interest rate on an older mortgage (as in older than this year’s rock bottom interest rates). If keeping your emergency fund in place means that you wouldn’t quite have enough to pay off your mortgage you might want to consider re-amortizing your mortgage. I read this interesting article on the NY Times: http://www.nytimes.com/2011/01/02/realestate/mortgages/02Mort.html?_r=1&scp=1&sq=recasting%20mortgage&st=cse
Although, I guess that wouldn’t really support the idea of paying off your mortgage as quickly as possible 🙂 But it seems like something you might want to consider in your situation. Plus it doesn’t come with the large fees of re-financing.
You should definitely play around with Dave Ramsey’s mortgage calculator to see what making a large lump payment towards your mortgage would save you in interest over the years. I love to geek out with that 🙂 We just bought a new home, and we are paying $13/month extra just because that keeps our mortgage at the price we were used to paying in rent and even if we never pay any more than that it saves us almost $5,000 over the life of the loan.
And also (I know this is getting long- sorry), you’re already saving $100/month, so if you added your mortgage to that you would be saving $800/month. It would only take you 12.5 years to get back to 120K assuming no interest rate at all, which means it will take even less time than that. SO if you have more than 10 years or so left on your mortgage I just don’t see any way that you wouldn’t come out ahead by paying your mortgage off ASAP.
Hope this is helpful!
Good article and comments.
I have another related issue. I’ve been told sometimes it doesn’t make sense to pay down our mortgage early because (since our interest rate is really good) we might come out ahead investing the money that we’d use for extra principal payments. In other words, the amount of interest money we make from investments would be less than the extra amount of interest money we spend on the house by not paying it off early.
Then again, the returns on a lot of investments these days are pretty mediocre…
@Haila, I guess my question right below yours is the same. Wish someone could explain it so it made sense to me… I just can’t see the advantage of paying so much per month to stay in debt.
We bought our house in 1988 and paid it off this month. We would pay extra toward our house payment whenever possible and really began to think about paying it off early when we found the tax deduction wasn’t as beneficial to us anymore. Plus, I believe that paying it off as soon as possible (even just a little bit early) saves more interested than the benefit of the tax deduction. Just a few extra dollars a month can make a difference.
Sarah in Alaska says
Can someone show me how the deduction is $1750. My math shows that the deduction would be $900 for married filing jointly.
@Sarah in Alaska, Jesse was using $1750 as a hypothetical number for the amount of mortgage interest a less-than-average mortgage per year. What do you mean by your figure for $900 for married filing separately?
Sarah in Alaska says
“With these assumptions, according to the calculator I used, first year interest payments would be just shy of $6000, with total monthly payments being just north of $7700 per year. The tax deduction would be right around $1750 the first year, according to the calculator, with an average over the life of the loan of approximately $1100. (Bear in mind this is quick and dirty math and the actual figures may vary.)”
It’s very easy to see that he is saying that the tax deduction amount (not the interest payments) is $1750. With the income numbers that Jesse provided, when I run the numbers through a tax return, the tax deduction is $900 for married filing jointly. It’s $1500 for filing single.
Sarah in Alaska says
No. $1750 was not the mortgage interest according to Jesse, it was the tax deduction.
When I use the income numbers he provided it appears the deduction is not $1750 but $900 for married filing jointly and $1500 for single. His point is even stronger if he uses the real numbers.
Sarah in Alaska says
@Sarah in Alaska,
Forgive me. I mean tax savings.
@Sarah in Alaska, Okay, I see that now. I thought he was saying that the mortgage interest was $1700.
I see what you are saying about your calculations – you are using the 15% rate for Married filing joint and 25% for single.
Sarah in Alaska says
@Sarah in Alaska, Actually I’m using the tax tables on the IRS website. But yes, it works out the same.
Sarah in Alaska says
@Sarah in Alaska, Jesse did give us the income of the indivdual, so I’m still curious how he came up with the 29% tax, when 68K is 15% for married and 25% for single.
@Tara, You are right – it would only be $900 (15%*$6000.) And that’s only assuming your total deductions are over $11,700 (the standard deduction everyone gets whether or not they paid mortgage interest, charitable contributions etc..) If this couple itemized and their deductions totaled $12000, they’re really only benefiting 15% of $300 (a whopping $45!) by having a mortgage/donating to charities. Not saying mortgage/charities are wrong, you just definitely don’t do them for the tax break.
Megwill's mom says
In our state, it’s not a reality to buy a house with cash for the majority of people. Even as the market deflates, homes in the “good” school districts still start at 300K+ and the property taxes can also be incredibly high. Rent starts at $1200-1600 for a 2-3 bedroom home so it really isn’t that much of a savings either.
Our state also gives a rebate to homeowners & renters which is an additional tax savings. While I certainly understand the advantages of a cash lifestyle; there are also ways your home can make you money (ie. solar power, etc.) and you can also get tax credits for keeping it in good repair. There are grant programs and incentives available for finding ways to increase your use of “clean energy”. Energy efficiant appliances, mechanicals (furnace, hot water heaters) and windows are just a few of the tax credits you’re allowed. Home ownership isn’t for everyone especially if you can’t fix things yourself or maintain the home alone.
If we had been renting and saving for last 7 years, we could have bought our current house NOW with cash. Because the market fell out here in Michigan our house is worth about half what we signed the contract for. So our current mortgage is at the same value as the housing market. We should be done in three years at the rate we are paying it down. So depressing! If we had only had a crystal ball! (Pun intended! In so many ways!)
@Julie, haha… too funny! Not the situation- it’s all just depressing… glad you still have your humor. 🙂
Sarah in Alaska says
@Julie, so glad to hear it will be paid off. Might have to come to your party.
So here’s my question: We received some investments about a year and a half ago when a family member died. We could sell them at any point for $5. They’re making anywhere from 4.5% to 7% and come due at different times from within 2 years to 30 years. We owe about 120K on our mortgage and would have enough to pay it off if we sold some. However, we are holding onto them and paying out the nose for our mortgage. Are we being foolish? Would it make any difference if we were planning on moving within the next 5 years or so (thinking not having all our capital tied up in the house)? My hubby and financial guy both seem to think the mortgage is a moot point and that’s never made sense to me. The mortgage is $1100/mo. roughly. I’d think we’d be saving close to $800-900/mo. once you factor in property taxes, etc. that come out of the escrow. Seems like we could get ahead a lot faster saving $800/mo. than scraping by each month to put $100 toward a retirement fund. Or do we really make that much interest at say, 6% on all that $$ to outweigh the mortgage payments? Any advice (from anyone!) would be appreciated! 🙂
@Sarah, You would need to consider the tax consequences of selling the investments too. Depending on the cost basis and the current value of the investments if difference is a gain you would have to pay taxes on that too. From your description they may be bonds, so if u sell prior to maturity u will be subject to market conditions. As interest rates go up the bonds value in the open market may go down. I hope that “the financial guy” u mention has taken ALL these factors under consideration when guiding u to the best option for your family.
@Sarah, If it were me, I’d pay off the mortgage.
For those of you that do taxes and all, I’ve heard rumors that potentially soon they will not even allow a tax deduction for a mortgage. Has anyone else heard that? Or not?
@Christy, Still a rumor – something lawmakers are considering to fix the deficit – one of many things they are considering.
Thanks for posting this, Paine family!
I totally agree with not buying a house for the deduction — I think that alone encourages people to buy more house than they can really afford.
We also need to remember that when you hold a mortage — someone ELSE (the bank) actually owns YOUR home.
My Boaz's Ruth says
My mortgage payment in Bellevue, WA ten years ago was less than $650/mo (And yes one reason I decided to buy then was that I could live where I wanted to for less than I can rent)
Now we are renting a house for $750/mo and not in a position to buy (maybe moving soon) We had to choose a location that allowed that cheap of a rent payment.
where can you have a mortgage payment of $650 or rent a house for less than that? not around here and I live in the midwest
we have a really modest 3 BR house and our mortgage is $900- I looked into renting a similar small house and the rent was $1000- seems like a better deal with the mortgage
@jan, I’m in Northern New England. We have an escrowed mortgage and we pay a little over $650 a month for our 3 bedroom home. Jobs are not plentiful or high paying here (which may be the reason for the lower mtg. payment), so I wouldn’t recommend moving. 🙂
That brings up another question though…I wonder if there is any difference in cost/savings with a regular mortgage vs. an escrowed mortgage.
Bethany at The Big Red Pot says
@Vanessa, I know several people with that payment or lower, in nice homes, in Arkansas 🙂
@jan, We live in the Midwest and have a very nice 2 bedroom house with a lovely backyard, with a mortgage payment of 611.00(but that’s with insurance and property taxes included!). It took us awhile to find the right house, but they are out there! 🙂
@jan, I live in the Midwest too-Upper Michigan. We pay 460/month for our 3 bedroom house, including taxes and insurance. But also the median income is around 20k…..
Hey there fellow Michigander!
We were renting a 3 bedroom house for $650/mo here in the Mid-MI area. Like others have said, some of us may seem like we have a much less housing cost, but in reality we’re probably making a lot less than y’all. I think median income around here is 33k. My hubby working IT full time and me part-time we’re only pulling in 42k/yr.
Erica @ Just Call Me Cheap says
@jan, I live in Massachusetts and to rent an apartment that is in a decent area in my part costs at least $900 for a two bedroom (no utilities included). The mediam household income is about $60,000 and the median house price is $260,000.
My husband and I moved to Georgia when we were younger because we wanted to move out of our parents’ houses and we couldn’t afford the rent in Massachusetts ( I look back and cannot believe we did such a crazy thing). My husband worked at an electronics store and was transfered so he got to keep his Mass pay rate. I found a job once we moved and believe me, I was paid a good two or three dollars less and hour than I would have gotten back home.
@jan, We have a decent 3/2 for around $670/mth, including taxes and insurance in Georgia. However, we’re in one of the poorest areas of the country and jobs can be scarce. There are definitely tradeoffs for the cheaper areas.
There is a way to get the mortgage credit and still have no debt. If you have a home equity loan on your home there is a mortgage filed. I you get a home equity line of credit it is ually active for 10-20 years. Most credit unions have no closing costs on their home equity loans and you don’t have to carry a blance. To keep it active you can just advance it once in awhile and pay it off right away. That way you have no debt and the exemption.
@Amy, Your tax deduction is equal to the amount of interest you pay on your home. Home equity lines of credit qualify like mortgages do, but if you keep the line of credit open and do not actually pay any interest on it because you do not use it, then you cannot take a deduction. Tax deductions can only be taken for actual amounts paid.
That is a tax deduction not a mortgage exemption. A mortgage exemption concerns your property taxes.
My husband would always say it was beneficial to have a mortgage for tax purposes too, which I never understood. And he could never explain it so it made sense. I guess me asking finally did something, because he just decided to refi to a 15 year so we can pay it off sooner. With the rates right now, we’re saving a TON in the long run. WOrks out well. In this area cash for a decent house would mean saving upwards of 200K!
@Noah, I agree. We just refinanced last month to a 15 year fixed mortgage. Our interest rate is 3.25%!!!!! Our mortgage broker told us it was the lowest % he had ever seen someone get.
I echo everyone else’s sentiments- I think that it’s actually very simple math. Your tax return will give back only a percentage of what you have already paid in interest. If you’ve spent $7,000 in interest, sure, you’ll get back $400 or so on your tax return. But if you didn’t spend that $7000 to start with, then not only would you still have your $400, you’d have the additional $6600 you had to spend to get it! I think that having a mortgage for the tax benefits is one of the silliest things I’ve ever heard!!
We bought our home 7 years ago and we are expediting our payments (basically just throwing extra money at it every chance we get!) so we are on track to have it paid off in about 8 years. Thanks for your continued inspiration!!
We have a mortgage but plan to pay it off early. One thing I’ve never understood about the mortgage tax debate…how could it ever be a bad thing to own the roof over your head free and clear? The way we look at it, once our house is paid for, we’ll at least have a place to live even if everything else spirals downward.
@Lise, One issue is that owning a home outright means that a large sum of money is tied up in an illiquid asset. If you experience long-term unemployment and exhaust you emergency fund, it is going to be hard to access the money tied up in the house.
Lea Stormhammer says
@Michele, For us we’d shave approximately $900/mo off our living expenses by eliminating our mortgage – just the interest and principle part of it, meaning that emergency fund would last longer.
I think the idea isn’t that you have everything tied up in the house – that you have a minimum of 3 months and up to 12 months of current living expenses (which can be stretched with part-time employment or slashing expenses in other ways). I don’t think that anyone is saying you shouldn’t have an emergency fund or that just having your money tied up in your home is a good idea.
For us, if we didn’t have a mortgage and burned through our emergency fund we’d have to find about $1000/month to keep our home (taxes), eat and have water and heat rather than $1200/mo on our mortgage payment alone! We can do that finding something part time. Yes, the money would be tied up in our home, but we would be able to live on far less per month, which is easier to do in general.
Hope that’s helpful,
Maybe you live in an area that has not depreciated and bottomed out in real estate – but thinking you can make your home a liquid asset in an emergency is just not rational.
After experience unemployment and a medical crisis back to back – we could not sell our home – after 6 months of plowing through our savings to pay the mortgage we were broke so we tried a short sell – STILL could not sell. Sadly after another 6 months we faced foreclosure of a home that we owed 80K more than market value – then after moving our of a home I sank my blood/sweat/tears/heart into for years we settled into a little rental home with our children and tried to start over with my hubby in a much lower paying job. THEN BOOM – our mortgage company sued us for the difference plus legal fees to the tune of 97K —
After much prayer and financial/legal advice we have filed for bankruptcy because we simply cannot afford to pay rent and that large debt.
Just don’t kid yourselves that paying for a home with a mortgage “frees” up any money.
It was real easy for us to think that with college educations and a 6 months savings we were “safe”.
Illness happens. Unemployment happens. Our home value (an any perceived equity) was gone. Value of our retirement savings were cut in half.
If our home had been paid for – this would have been so much easier to live through…..
Jesse Paine says
@Dawn, Dawn, you hit the nail on the head as far as one of the main reasons for paying off your house is concerned–risk management. I listen to a number of financial and real estate podcasts and am always amazed at how risk neutral some folks can be when it comes to leveraging your house or real estate assets. There really is a peace of mind when you own something in it’s entirety and not just in part. Dawn, I also wanted to encourage you and your family. Bankruptcy is a hard thing to decide to do and, while there is a stigma about filing, many times you are left no other choice but to try to get a fresh start. Be strong and press on. You will come out of it with renewed resolve to make sound financial decisions in the future. I see so many people that enter into bankruptcy with the attitude that they will just file again when they get under water nine years later and do not undergo the behavior change necessary to succeed. I can tell from your post that you are well on your way to getting back on track. Don’t be ashamed, stay strong.
We see things a bit differently. Since a house is an illiquid asset, it is difficult to assess the money if you get in a tough spot and need money, say you experience long-term unemployment and have exhausted your emergency fund. Secondly, mortgage interest deduction is our single largest tax exemption (we always itemize). Our tax burden would be considerably higher without it. We invest the money we “save” from the mortgage interest deduction, which in turns grows because of capitalizing interest (hopefully at an overall rate higher than our actual mortgage rate). We also refinance about every 6-7 years to insure the majority of our payment is tax deductible.
@Michele, If your mortgage interest deduction is your single largest tax deduction (I believe that’s what you mean instead of exemption), then it is probably one of your largest expenses period. If your mortgage was paid off, you could invest what you used to pay in interest. This would also grow by the power of compound interest (I believe that’s what you mean instead of capitalizing interest). Also, if the majority of your payment is tax deductible, that means the majority of it is interest, so you’re hardly increasing the equity in your home that you seem to desire to tap into if there is an emergency.
I think Jessee’s answer is a little complex. Here is some simple math. Say you’re in the 25% tax bracket and you paid $1000 in tax deductible mortgage interest this year. This would reduce your taxable income by $1000. 25% of $1000 is $250, so this reduces your tax bill by $250. You’ve sent $1000 to the bank to avoid sending the government $250. If you really want to send large sums of money elsewhere to avoid sending the government small sums of money, you might look into charitable giving, which gets the same tax treatment as mortgage interest.
Thanks for the comment. We tithe 10% on gross and also give to other groups beyond that. Charity is our second largest deduction. The numbers might look differently for us if we lived in LCOL or even MCOL area, but because we live in an HCOL the opportunity cost associated with paying off an entire mortgage is substantial (we are also in the 33% tax bracket), even when using conservative figures for investment returns. We also need to maintain a sizable emergency fund, since we rely on one income that would be difficult to replace should my husband become unemployed.
Andrea Q says
While I completely agree with your scenario, home prices in some areas of the US (even for a modest home) make it next to impossible to buy a house with cast. The median price of a house in the Northeast is about $240,000 (the only area of the country where home values are still rising). The median price in the Midwest is about $140,000. For many homeowners in the expensive areas, the mortgage deduction is much higher than the standard deduction (even with no other things to itemize).
Andrea Q says
Sorry for the typo…that should be “cash” not “cast”!
I agree, i live in the northeast and between local property taxes and the interest i pay, i blow the standard deduction away. Here it’s only about $100-200 monthly difference between renting and mtg’ing with a good down payment. Rents are high that we would still be saving for a home.
We should be in a position soon to add additional money to the principal, but in the meantime we need to focus on other areas. We like “owning” our place vs renting so it’s worth having the debt in our eyes.
My boyfriend and I live just outside of NYC and our rent is $1800 a month (for a one bed, one bath apartment, parking and utilities NOT included). When I hear that people have mortgages for 1/2 of what we pay in rent, it makes me even more motivated to move away from the Northeast. The first decent offer bf gets will guide our next move. We really want to buy a house and have been saving about $2k a month for a down payment. But here, $300,000 wouldn’t even get you a 1-bedroom in a shady neighborhood. Crossing my fingers and saying a prayer that we’ll be in a new city by this time next year:)
@Kari, Keep in mind that even with the midwest prices of $140,000 on houses, the salary scale is also that way too. What a person in the midwest makes (minus that you’re not self employed or big exec) – i.e. $68,000 salary is $88,000 elsewhere.
Katie W. says
@Michelle, But there is an AMAZING difference in percentage-ratios, when you live in a high-cost-of-living area. Yes, the income is different, but it’s the %-of-income-to-cost-of-housing that is startling. I, too, live in the Northeast.
I too agree with Jesse and Crystal that buying a home for cash would be ideal but I found these comments reassuring. We live in the suburbs of Philadelphia. Landlords here cite fire regulations and will generally not rent a smaller home or apartment to a family with several children. 3 or more bedroom rental homes, when they appear, cost as much and in some cases more than a mortgage+taxes (as they tend to pass the high tax burden on to the renter) We searched for an affordable home to either rent or purchase for our growing family for two years with zero success before finally taking on a substantial mortgage. We’re now working to pay it off early of course. 🙂
Thanks for this explanation, Jesse. I think we live in a society that believes that having a mortgage is synomous with owning a home… and it’s not. It’s just a vehicle to get you to the goal of owning the home. For years, my dad refused to pay off his mortgage, when he was finanacially able to do so, because of this tax deduction. Several years ago, my stepmom got cancer, then the stockmarket crashed and his business took a very hard hit. Last year my dad died suddenly of a heart attack, leaving my stepmom with a mortgage she could not afford and without the resources to pay for it (they have been eaten up with 10 years of cancer treatments). So the real owners of the house (the bank) took the house back and my stepmom was left with nothing.
What we have taught our children and what we believe this story illustrates is that a mortgage isn’t bad or that people who have them should be “looked down upon”, but that the goal is to own the home and that when you have a mortgage, you don’t own the home, the bank does. So you should work to get to the goal quickly, because you never know what turns life can take.
Also, when you no longer have a mortgage, you could give 100% of that $650 a month to chartiy and take at dollar for dollar tax deduction.
Andrea Q says
“Also, when you no longer have a mortgage, you could give 100% of that $650 a month to chartiy and take at dollar for dollar tax deduction.”
That’s an excellent point, @Angi!
@Andrea Q, Maybe I misunderstand your phrasing of this, but I wanted to clarify something: a deduction does not mean dollar for dollar reduction of your tax. It means reduction of taxable income. Your tax savings on your donation is your income tax rate times the donation you made. If you donated $650 and your tax rate is 25%, you save $162.50. I am not trying to discourage charity, but please don’t give $65o for charity thinking it will save you $650 on your tax bill. (I do this for a living, BTW. Just trying to help and not trying to be a know-it-all.)
Thanks for the clarification, what I ment was that the full amount of the $650 was calculated into the deducation, not just the interest part.
@Tara, Thank you so much for your explanation, I always wondered how the amount of tax deduction was figured from charitable donations! 🙂
Oh, yes, I’d like to pay an extra $50K for my house so that I can save $5K on my taxes! Sign me up!
If you are going to have a mortgage, then this deduction is a nice benefit to those who can itemize their taxes. But in itself, it is absolutely no reason to keep a mortgage going longer than necessary.
By paying off our home mortgage early (to be finished by 2012), we will have saved thousands of dollars in interest. In contrast, being in the 10% tax bracket, we’ve saved maybe a couple hundred a year in taxes from the mortgage interest deduction.
One thing people don’t seem to understand about tax brackets- you aren’t taxed by your gross pay level. We make in the $40k’s, but by the time you subtract our personal exemptions and standard/itemized deductions, we drop into the lowest tier and are taxed at 10%. Most people aren’t taxed at the 25% and above rates, and even those with larger incomes have only a portion of their income taxed at those rates.
By the way, I can put a price on the pride of owning a home – we just sold our house and moved in to an apartment. It saves us $600 a month, which amounts to $7200 a year. Would I rather be proud or save the money? Hmmm. I think I’ll opt for the latter! Instead of my lovely raised bed, we’ll have container gardens this year…
I don’t think anyone is being “look down upon” for having a mortgage – the question is, is it better (financially) to pay off the mortgage early or simply buy a home with cash (obviously, yes it is better) or should one carry a mortgage and make payments for a deduction at the end of the year.
So, your “pride” in having a home and all emotions aside, the point is that it may be more logical and prudent to rent, save up the money and buy a home outright or, at the very least, put down a sizable down payment and get a head start on knocking the mortgage out.
@Jennifer, I love the debate of rent versus buy! and i love hearing peoples input! i think Jesse had a great point when he talked about the length of time it would take someone to save up cash for a home being an important factor. my husband and I are currently renting and out rent and utilities combined are currently less than what most people pay for their taxes per year in our area. we live in an area where home prices are from 200,000 to 800,00. we are currently very content renting in our little one bedroom apt but know that once kids come along the rent for a two bedroom apt will be more per month than a mortgage payment on a modest starter home. also it would take us up to 5-10 years to pay 100% down while living on a teachers salary. so.. our goal is to put down at least 20-30% on a home that is below our means and pay it down as quickly as possible. I truly believe 100% down is the way to go but like crystal has said many times everyones situation is unique and no matter what all our decisions should be prayed about!!
Laura Jane says
@lindsay, Interesting point about your rent+utilities being more than most the property taxes for most homes in your area. We are in a similar situation. We have no kids yet, so we are content living in a slightly smaller place than we would if we bought a house now. We looked into to buying. On the surface, a mortgage payment would only be a couple hundred/month more than our rent. However, looking a little deeper, we discovered that our property taxes, increased utilities (for a larger home vs. our current rented townhome with neighbors touching on 3 sides), homeowners insurance, and estimated necessary repairs/maintenance alone (not counting the temptation to spend more on upgrades and furnishings and things like that or mortgage interest) would be GREATER than our current rent. Another way to look at it: if somebody completely gave us a house we would spend more money for it than we do renting. This is another reason why it can make sense to save up money while renting in some situations. I think a lot of people neglect the extra costs when they consider rent payment vs. mortgage payment.
@Laura Jane, its true! i know if we had our own home right now i would be tempted to put alot of money into it for decorating, painting, etc. and the not having to pay for any repairs is awesome too. we had our water heater break about a month ago, we called our landlord that morning and it was fixed when we came home from work.. no cost to us!! as long as we fit in our current apt it is def a benefit. but we will reevaluate when our rent gets to be more than a mortgage will be!
I am a tax accountant and I agree with you, Jesse. You should never ever incur an expense for a tax deduction. A deduction means that you are deducting from the amount of income that is allowed to be taxed. Many people misunderstand this to mean that this is directly deducting from your tax.
If you have paid $1700 in mortgage interest for the year, to use Jesse’s number. that is $1700 that you can deduct from your taxable income. If you are in a 25% tax bracket, that means you have saved 25% of $1700, or $425.
If someone told you to spend $1700 just so that you could save $425, you would probably say that this didn’t make any sense, and you would be right.
Please remember that a tax deduction does not mean a dollar-for-dollar reduction of your tax. The average person should never spend money with the sole justification that something is “for tax purposes.” (Granted, there are several more sophisticated scenarios out there, and I am not talking about those.)
@Tara, I couldn’t agree more! Although the tax deduction is a nice benefit, it certainly shouldn’t be the sole reason to obtain a mortgage. Unfortunately the term “deduction” is commonly misused and understood to mean something that it is not even by well-educated and often finance-savvy persons.
From another tax accountant…YES! Thank you!
@Tara, Okay, so I misunderstood Jesse’s numbers above – he was saying the mortgage interest would be about $6000, not $1700. But the concept is still the same
@Tara, One other thing I never see people mention, is that even if you’re itemizing your mortgage interest, that doesn’t mean you’re really deducting (in this case) all of that interst. To clarify, the standard deduction for married couples is $10,700. If you itemize and get to a total deductions of, say, $13,000, you’re really only getting a deduction advantage of $2,300, not the $7000 you think you are since you would’ve been able to deduct $10,700 with or without your mortgage interest. Does that make sense? So really, the benefit is only 25% of $2300 – for any deductions (mortgage, donations, medical expenses … whatever it is you’re deducting.)
Brandi S says
Thanks for clarifying b/c I seriously thought we were getting everything back that we paid into interest for the year and have been trying to figure out why we didn’t for the past 2 years. We are a single income family (husband, wife, 2 kids) and haven’t ever gotten more than $8000 back even though we itemize…..
@Brandi S, No, you don’t get it all back. A deduction lowers the amount of money you pay taxes on. So if you made $50,000 and had $15,000 in deductions, you pay taxes on $35,000, not the $50,000 you made. At that bracket, a couple would be paying 15% tax – so the $15000 saved you $2250 in taxes… nice! BUT, even if you had no deductions at all (no mortgage interest, no charitable contributions etc…) you would get the standard deduction of $11,400 for married couples in 2010. So really, that $15000 in interest and charity gifts really only saved you $540 (15% of $3600 – the difference between $15000 and $11400.)
Brandi S says
Hmmm…that does make more since and about right for our income. Maybe I should let a professional figure our taxes next year and not a family friend who does taxes on the side b/c we haven’t been getting anywhere near that back with us (married w/ 2 kids). Alisha, thanks for taking the time to write me back on that 🙂 I appreciate it and am less confused now
Brandi S says
Hmmm…that does make more since and about right for our income. Maybe I should let a professional figure our taxes next year and not a family friend who does taxes on the side b/c we haven’t been getting anywhere near that back with us (married w/ 2 kids). Alisha, thanks for taking the time to write me back on that 🙂 I appreciate it and am less confused now
@Alisha, Exactly! We have itemized our deductions before and taken advantage of the mortgage interest deduction, but it had no bearing on our decision of getting the loan itself. The tax benefit is small compared to the amount of interest you pay! And as Jesse said, few people itemize in the first place.
I get your explanation, but it’s hard to put the price on the pride of owning a home!
I delight in landscaping as I please, having a large, wonderful vegetable garden (which provide us with loads of free produce in the summer), having a paid-for patio on the back of our home…the list goes on and on.
We do use the itemized deductions for taxes.
Every family is different, but I don’t think that people should be looked down upon for having a mortgage!!!!
@Lauren, If you read this blog long enough, you will know that Jesse and Crystal don’t look down upon people with mortgages. They have chosen to pay cash for their family and think that it can work well for others too, but understand it’s not for everyone!
Yes, Dawn, I’ve been reading for about a year now and know that…but sometimes peoples comments in response to posts like this can come across as “looking down”.
Crystal once wrote that she didn’t recommend that most people live the way they live, and I agree! It takes a type of resilience and strength that most people don’t have! That being said, I feel that I live a blessed life, being able to stay home with my boys and make extra interest payments on my mortgage so they will eventually be “real homeowners”!
I love this website even if I don’t follow everything on it and admire the Paine family greatly.
Saidah @ AProverbsWife.com says
I worked as a financial planner and the approach our company offered customers were accelerated payments. Many of my clients initially hesitated taking this option because they felt that they would lose the benefit of having that deductible on their taxes. After showing them the benefits on paper some of them still (reluctantly) modified their mortgages to pay it off early. I think people have accepted a big lie about some debt being “GOOD DEBT”.
@Saidah @ AProverbsWife.com, I think the problem is the term “good debt”. It’s always better NOT to go into debt – IF you can afford it.
“Good debt” should really be called “not-so-bad debt” or “debt to finance a long-term benefit”. School loans and home mortgages aren’t BAD, but they’re not GOOD, either – except as they allow people to have opportunity to improve their lives that most couldn’t afford if they were paying cash.
@Anitra, I love the term “not-so-bad-debt.” Or maybe, “not-as-bad-debt” would be more appropriate. I think I’ll use that one if you don’t mind.
I’m amazed at how little people understand about their mortgage. I asked a friend recently if he was close to paying off his condo (I thought he must be considering how cheap he’d gotten it, and he was a single guy with few expenses.) He said he never paid extra – but that he had sent in an extra payment once so that if he forgot to pay one month it would be OK because he paid ahead. The poor guy thought a mortgage worked like a car loan! It amazed me that he could have a mortgage for over 10 years and not understand the basics. I had to explain, in no uncertain terms, that he had not “paid a month ahead” like he’d thought and that the bank would very much expect a payment each and every month.
Shelli W says
I think it’s also important to note there technically isn’t a tax benefit to having a mortgage versus not. Using your figures, if you have an annual mortgage outflow of $7,700, yes you may have a credit on your taxes for just under $2,000 BUT you are also out that $7,700 for the year.
if you DIDN’T have the mortgage, you would have had the $7,700 minus actual income tax (but considering a house in that price range, most likely NOT at the highest tax bracket) of probably 15 – 20% so minus $1,500 even. I’d take the approximately $5,000 difference personally.
@Shelli W, I think this is a big thing that needs to be pointed out. You might not be able to deduct the interest and lower your tax liability, but w/o a mortgage you would still have all of that money!
If you don’t want to have the money, then you can give it to a charity and keep the deduction. 🙂
@Shelli W, you hit the nail on the head!!! It’s like trading someone a $100 bill for a $20 and thinking you got a good deal out of the trade. How ludicrous!!!
Laurie A says
@Shelli W, I can’t agree more! It doesn’t make sense to carry a mortgage simply to get a deduction on your taxes any way you slice it.
I completely agree! We bought our first home right before the real estate boom and paid $65,000.00. We are currently working on paying off our other debts, but we know sooner than later we will be able to chip away quickly at that $65,000.00. We currently do not include escrow in our mortgage either, using the methods learned from taking a Dave Ramsey class, we divided the total amount of our taxes by 12, and deposit the amount we need monthly into a money market account.
@Stephanie, Does your bank allow this? I’m embarrassed to say I just assumed you HAD to use escrow. I get annoyed b/c every year we get a rather large “escrow refund” that I’m NOT making interest on.
It depends on the laws in your state. In some states, the lender can require an impound/escrow account for taxes/insurance only under certain circumstances. In California, for example, the circumstances are:
1. Loan-to-value ratio greater than 80%
2. FHA and VA loans
3. Owner fails to pay or is late paying the taxes or insurance premiums.
In other states, lenders can require impound/escrow any time.
Even in those states where lenders cannot always require impound accounts, there will often be a form that the lender has you sign at closing “opting” to have an impound/escrow account. You have to know your rights and make it abundently clear that you don’t want one.
If you have a conventional loan with an LTV of less than 80% and are sure that you have the discipline to set aside money to pay taxes and insurance when due, then ask your lender or servicing agent about the possibility of cancelling your impound/escrow account.
In some states, the lender is also required to pay interest on impound accounts. The interest rate is often paltry – in California it is 2%. But then 2% is better than what a lot of bank accounts are paying right now.
@Camille, We have one of those loans where escrow was required; it was a local bank-specific loan for low income homebuyers. In our case, the taxes have been going up slightly lately, so having an escrow account has meant that this increase was spread over the year vs. having to pay a lump sum, which has been useful. The lack of interest earned is worth the trouble of not having to calculate the changes each year, imo. I could see this varying a bunch, though, based on how much money you’re actually talking about (for us, it’s around $100/mth).
@Stephanie, Does your bank allow that? I never even thought to ask if we didn’t HAVE to use escrow!
Thank you Jesse! I think that many people are so used to having debt that they can’t see the savings of having a paid for home. Free rent payments with only taxes and insurance and upkeep to pay for is always a better deal than getting a little money back from the government. Over the useful life of the house you will save more in mortgage payments than you ever would have received in deductions.