Friday, July 16, 2010

Mortgage Interest Deduction: Myth or Freaking Awesome?

Mike in LBC wrote in with a great question. In case you don't read the comments (come on, join the discussion!), here is what he asked:

El Bee, could you school me on a blog when you have a few?

This article will probably interest you regardless:

But I was particularly interested in the "myth" that you don't save in tax deductions from the purchase of a home.

I'm really scratching my head about THAT one.

Here is what that section said:

"I'll get a tax deduction." While the government provides a tax deduction for mortgage interest as well as other tax credits related to energy-efficient appliances and other green technologies, these benefits do not outweigh the expenses. Many homeowners find that even with the availability of a mortgage interest tax deduction, their tax return isn't affected because they are better off taking the standard deduction.

Below is my response.


I don't own, so I can't relate any personal experience. But I have heard from some people that the mortgage interest deduction isn't all that great. The primary reason is that there are so many other ancillary costs associated with homeownership. Lawn care, repairs, upgrades, pool maintenance, special assessments, busted appliances, leaky roofs, insurance, [edit: HOA fees,] etc. etc. It makes it pretty much a wash.

When you are a renter, you don't have to worry about any of that shit except for some utilities (homeowners have to worry about ALL utilities). And homeowners have to fret about special assessments, future increases in parcel and property taxes, increased utility rates, etc. You don't find that stuff on a bank's mortgage calculator.

And the article doesn't mention any of that! Meaning buyers aren't thinking about it either. The one I consistently hear from my homeowner friends and family is: "You have no idea how many, and how quickly, little expenses add up when you own."

That is why I personally calculate the pre-tax payment as a better comparison for rent vs. buy. That's more "real-world" and provides some cushion for unanticipated costs. That way, any tax write-off not offset by ancillary costs is pure gravy.

You can calculate the after-tax payment, but you can't COUNT ON IT, know what I mean? Like the article said, some people find out (after they've purchased, mind you!) that there is NO BENEFIT to itemizing and taking the interest write-off -- they're better off just taking the standard deduction! Could you imagine?!

As we're seeing in this current economic bust, too many people lived on the edge. And they are one unemployment spell or pay cut or busted water heater away from losing their house. Always always always plan for the unexpected.

I welcome any input from readers (especially those who enjoy the interest deduction every year) regarding your experiences/perspectives.


  1. LB,

    The Federal tax deduction is on interest so at the beginning of the loan it works pretty good and not so good after a few years. The real problem is that the deduction is usually very close to the amount of your property tax -- so its a wash. Of course then you have to add all the things you mentioned you have have pride of ownership.

  2. I have owned several houses. When my wife and I were making little money, just out of college, the tax deduction lowered the cost of ownership, so that it was only about 15% more expensive than renting.
    As our income increased, the deduction was a smaller part of the equation. If you are subject to the AMT on taxes, (as we are), it is totally useless.
    But for many people, ownership is a forced savings account. I know many people at or near retirement, and the house, now worth hundreds of thousands, is the ONLY major asset they own.
    Buy a house at age 35, with a 15 year mortgage, and it is owned free and clear by age 50. Quite a nest egg for most people.

  3. The AMT makes interest deductions meaningless as a tax benefit. But that isn't why I bought a home.

    IMO, in the last decade, way too many people got interested in homes as an investment. Buying a home versus renting is a choice, and which way you should go depends on your station in life. Young single guys that have plenty of income and savings may take a bender on a home or a condo, but often they'd be better off renting. When they meet and marry their significant other, I can guarantee that their "crib" is not going to work. She'll want a new nest.

    IMO, that nesting instinct is what should drive most first-time home purchases. Not where you'd guess the housing market will be in a couple years.

  4. My main point of confusion was the part of the article that stated that there was no advantage to using the mortgage tax deduction, versus the standard deduction. That blew me away.

    If that comment is based on things like the AMT (Alternative Minimum Tax), then I think it's a VERY misleading statement.

    I totally am aware of property tax, mortgage insurance (for those who can't afford to put down 20%), HOAs, and similar home owning fees.

    The fact that a mortgage tax benefit offsets those things, is what I expected.

    If you can squash the added fees with the tax benefit, then the mortgage payment becomes a savings account, versus renting where you are just throwing money out the window.

    Now of course, if the cost of owning is GREATLY higher? Then yeah, it makes more sense to rent....

    But if you can own for even 25% more, to me it seems wiser (IF you can afford the higher payment), because you are building equity.

    Even if the house doesn't go up in value, you still have the equity you've built.

    Am I missing anything?

    thanks El Bee

  5. That site is national...while in CA with high prices, interest is a big $ amount ($500k@5% is $25k/yr!), if you are in a place like TX or OH where houses cost $125k (@5%=$6k/yr) it is not over the std deduction (?~$12k?), and so it isn't worth much, if anything.

    Even if you make lots, but not enough for AMT (say $150k), itemizing generally only yields about 25% deduction (so say my cpa friends).


  6. Indeed, buying a house is a forced savings account. When I got married, we bought a house, with payments about 20 percent higher than rent.My roomate rented another apt. in San Francisco,(rent controlled), and has lived there for 30 years(still single).
    Our house is now paid off, and worth over $500,000.
    My old roomate has about $15,000. in savings.
    As I said, forced savings. The real benefits do not accrue until your 50's or so.

  7. oc bear said...
    ... The real problem is that the deduction is usually very close to the amount of your property tax -- so its a wash.

    ??? The property tax is also deductible... Here is an example how the numbers work. If the mortgage is in the mid $300.000s, the itemized deductions without any medical expenses can reach the point, when the actual saving is about $750.00/month. The tax withholding ratio can be synchronized with the actual tax benefits, so the monthly $750.00 become cash in hand. If the income comfortably supports the mortgage, insurance, property tax (and HOA fee) payments, this $9,000.00 / year in good hands is a serious dough. Obviously as the mortgage getting older, this amount is getting smaller and smaller, but for many years, it's still a serious cash in hand.


  8. Surfer Steve in LBCSunday, July 18, 2010

    The wife and I have seen both sides: renting and owning in Belmont Shore. We sold our house in 2005 and have rented since then. People thought we were crazy at first (or financially destitute), but now many friends confide that they are a bit envious at our freedom. I do agree that first-time owners greatly underestimate the maintenance and repair cost, especially on an older home like we had. The mortgage interest tax deduction is over-rated, especially if you take into account your financing cost during the life of a loan. If you think you are staying in one area for 10+ years, than buying makes sense. Otherwise, renting is so much easier, less expensive, less cumbersome, and provides a much greater ability to control your own destiny (think of all the people stuck in upside down homes right now).

    Just my thoughts . . .

  9. As a recent homebuyer, would agree with all the above. This year we got killed on taxes. Next year we will owe about 1/2 as much to the feds, because of the mortgage interest and property tax deductions. Having said that, owning a home does cost a lot more than renting, for all the reasons discussed above.

    One thing I don't miss about renting is recently I had to go to small claims court to keep my greedy-ass former landlord from trying to steal my security deposit on my former rental. Of course the bastard had to fork over what I had coming, but it took a court-appointed mediator to get him to see the light...

  10. I think what would really be helpful, is if someone could run some basic numbers, with and without a mortgage tax reduction.

    Take say 75K annual income, and see how much tax you would pay with and without the deduction, on say a 250K home.

    I'm trying to do this myself, but I've never filed the tax form for a home-owner, and I'm not sure how to do it.

    The web-based tax sites like "" make it easy to run the numbers, but you have to know how to run the mortgage tax numbers....

  11. As a Long Beach CPA, involved heavily in real estate ... you are right on!