Almost everyone knows the interest-rate tax deduction is a key benefit to carrying a mortgage.
But maybe it’s not worth as much as you think, especially if your income is no more than modest. Rarely, if ever, does the deduction justify taking on a bigger debt.
Federal income tax rules allow taxpayers to deduct the interest paid on mortgages for first and second homes. The year’s interest payments are subtracted from income, producing a lower taxable income and reducing the tax bill. Interest on home equity loans is generally deductible as well.
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In the common way of looking at it, the savings is based on the homeowner’s “marginal” tax rate, or rate paid on the final dollar earned. If you are in the 25% bracket, the deduction reduces your taxes by $25 for every $100 paid in interest.
Today, the 30-year fixed-rate mortgage averages about 5.5%, according to the BankingMyWay.com Survey. The Mortgage Tax Savings Calculator shows monthly payments on a $300,000 loan would be about $1,700. In the first month, about $1,375 of that would be interest, the rest principal. Interest costs would drop slightly every month as the balance on the loan gets smaller.
A homeowner in the 25% tax bracket would save $4,100 in taxes on the $16,400 paid in interest during the first year. During the life of the loan, interest would total about $313,000. Tax savings would be about $78,000, assuming the bracket stayed the same.
But the common view doesn’t account for another key factor: The standard deduction available to taxpayers who do not itemize their returns to claim mortgage interest, local taxes, charitable gifts and other deductions.
For 2009, the standard deduction is $11,400 for married couples filing joint returns, and $5,700 for single people and married people filing separately.
