December mortgage update: A thought about mortgages and itemization

Last month (November):

Balance: $88,761.62
Years left: 7.25
P = $857.03, I =$357.37, Escrow = 621.66

This month (December):

Balance: $87,234.63
Years left: 7.083333
P = $863.05, I =$351.35, Escrow = 621.66

One month savings:  $2.62

When I was reading up on amortization, I came across this comment on mymoneyblog.  Milhouse has just made the point that your effective interest rate is lower when you itemize and take the interest deduction with your mortgage.

Maury Says:
<July 18th, 2009 at 7:40 am
Milhouse,

I used to make that exact argument, but when I actually started doing my taxes, the math didn’t work out. The thing you have to keep in mind, is that you ONLY benefit from interest you pay above and beyond your standard deduction. I’m married, so my standard deduction is $11,400.

In other words, if I pay $11,000 in mortgage interest this year, I would be better off NOT claiming any of that as a deduction and taking the standard deduction.

To put that in real terms, If I had a $183K loan outstanding and was paying 6% interest (the aforementioned $11,000) I would see no tax break from the government. I would still be effectively paying 6%, not 4.5%.

This is something I had not thought about before.  This past year, I paid about 5K in interest.  Does that mean that we’re not getting a bigger break than if we hadn’t itemized?  Of course, there’s also charitable deductions and other things that only count when one itemizes, and having a mortgage also makes those worth more, because otherwise they’d be included in the standard deduction.  Is this an argument for doing more pre-payment as you get near the end of the loan as your effective interest rate changes with the loss of itemization?  (Or perhaps an argument to do more charitable donation?)

I don’t do the taxes in our household (they stress me out), so I’m not quite sure what else we itemize and how much it all adds up to.  But it’s something to think about.

Update:  Our mortgage interest may be only 6K/year, but when you add that to the state tax deduction, that puts us over the standard deduction and thus makes any additional charity donations deductible.

What do you think of the mysterious Maury’s argument?  Is it one you’d thought about before?  Is he right, and if so, is it worth it to you to itemize?

17 Responses to “December mortgage update: A thought about mortgages and itemization”

  1. Jennifer Says:

    That! I make this argument over and over and over again to everyone who talks about the tax break. The marginal reduction in taxes from just your interest deduction is, for the majority of the population, zero.

  2. The frugal ecologist Says:

    It’s slightly in our advantage to itemize – our itemized deduction is about $12k. So, like you say, we are just getting the advantage on $600. Not much! And it’s a lot of work to itemize even though we keep all records electronic. In a few years as our mortgage interest decreases it won’t be worth it at all.

  3. NoTrustFund Says:

    This is something I need to look into more. I used to do our taxes when they were easy peasy but they’re not anymore and our tax advisor is not super helpful in this area. She told us to take out the largest mortgage possible, ‘let someone else pay for your house’ was the way she put it. She’s good at what she does, but clearly we do not see eye to eye on finances!

    • Leigh Says:

      That’s what my last accountant told me too! He told me that buying a house was the only other way I could really save on taxes. I’m going to try doing mine this year and I’m hopeful. My boyfriend thinks I’m crazy that I’m looking forward to doing my taxes, lol. I have a feeling I’ll end up doing his too…

      • Kellen Says:

        And they try so hard in accounting school to teach us that not every decision that will lower a client’s taxes is actually a good business/life decision.

  4. Leigh Says:

    One of my coworkers is obsessed with the mortgage tax deduction! He just doesn’t get that if you have a low interest rate and a reasonably small mortgage, you won’t pay enough interest for it to make sense. (My property taxes are also lower than his.)

    This year, I should save a whopping $200 by itemizing my taxes. In 2013, $1000, then $600-700 and $100-300. If I was married, I wouldn’t be saving anything since my itemizing sum would be under the (current) married standard deduction.

    In the last proposed year of my mortgage, my itemizing sum would come in under the standard deduction, so I’ll probably end up paying the mortgage off once the balance is under that of one of my savings accounts. But, who knows what will happen in the next 4 years!

  5. nicoleandmaggie Says:

    I’m pretty sure that Turbo Tax tells you whether you’re better off itemizing or taking the standard deduction, and with our charitable giving thus far we’ve been better off itemizing. But that will probably change soon!

  6. bogart Says:

    Um, right. I think this likely applies to lots and lots and lots and lots of folks now but probably only to lots of folks in a higher-interest rate environment. Let’s not forgot that (for the record, I’m completely in favor of doing away with the deduction entirely — am not advocating it! But neither do I think it’s fair to assume that it’s “usually useless” if we only use recent data to examine that. Unless of course we’re clear about the limitations of our analysis. But I digress!).

    I believe my household typically comes out marginally ahead, but our property and state income taxes are fairly high — we have to itemize to claim those, right? And yes, there are charitable donations (which we plan) and some years, there have been medical expenses (not so much). Still, I do sort of figure that there will indeed come a moment when we would be better off to pay off the whole mortgage as a lump sum rather than continuing making payments. But I also figure that by that moment, the interest rate we’re paying will be so absurdly cheap relative to other financial opportunities (e.g. rates on bonds, CDs) that we’d be fools to pay off the mortgage early. So — time will tell, I guess. For now, we’re continuing to pay the minimum, and happy doing so.

  7. Debbie M Says:

    I always itemize when it adds up to more than my standard deduction which, since I bought a house, it always has. I had thought that when I paid off the house, I might stop itemizing, but property taxes (high in my state) plus charitable contributions = it’s better to itemize. If I get married, that will change. (Unless maybe property taxes skyrocket!) Meanwhile, I may try the strategy of itemizing every other year: paying property taxes for one year in January and for the next in December.

    However, the reverse strategy–getting a mortgage so I can reduce my taxes–is not something I would do. Maury is right: you only get a break on the amount beyond your standard deduction and only if you itemize. Maybe back in the 1970s, some people in the 90% tax break could almost get the government to pay for their house (except for, you know, all the principal), but otherwise, that’s crazy talk. I also don’t pick investments based on tax considerations (though I will wait to sell until I’ve owned a stock for a full year).

    I think some people get confused between the two kinds of tax breaks. One is where you don’t pay your taxes on some kind of expenditure, and one is where you reduce your taxes by the entire amount of your expenditure. Mortgage interest is the former.

    Disclaimer: My marginal tax rate is 15%, so it’s not that big a deal either way.

  8. Cloud Says:

    We use a tax accountant, and he runs the numbers with and without itemization- but we’re relatively high earners in a relatively high tax state, so we’ve been itemizing since before we had a house, due to our state taxes. The bigger question for us each year is whether or not we’ll be paying the AMT. So far, we’ve only had to pay AMT once, but we’re skating on the edge. Not that I’m complaining too much, mind you. I’d rather be worrying about whether or not I’m going to pay the AMT than worrying about whether or not I can afford to pay my bills!

  9. bethh Says:

    aaaaaah That was so very interesting! I am buying my first home and have been hearing about this amazing tax benefit for years, without knowing exactly how it works. This makes so much sense now – and having a house will be worth about 3k extra for me in deductions, so itemizing will be a clear win. Still – it’s not the mega landfall I’d been half-expecting.

  10. Susan Says:

    It really bothers me that the mortgage tax “break” is so highly regressive, in that you have to be wealthy enough to outspend the standard deduction — yet it’s politically untouchable, even now. I wish more people understood this … especially when W. was touting his home-ownership goals.

    • Joanthan Says:

      Obvious solution – get rid of the standard deduction! Then everyone would get the benefit of home ownership (as well as charitable giving!). The way I see the standard deduction as someone who itemizes is that it eats into the value of my charitable giving since the first $11,600 only goes toward getting up to the standard deduction which I could take anyway.

  11. Kellen Says:

    You’re really “getting money from the government” way more if you have almost nothing itemizable, but you get the standard deduction anyway.
    If I don’t have mortgage interest, etc, I still get the standard deduction of $5,950. If I pay mortgage interest, real estate taxes, etc, and they add up to $6,000, I only get $50 more deduction for spending $6,000 more.

    Of course, if you’re renting you are paying higher rent to cover the mortgage interest for the landlord essentially, etc, etc. But still. It’s not really a big tax break. And they’ve done studies to show that housing prices just increase to compensate. And since not all buyers are going to be in the same tax situations, some buyers have to pay the increased cost without really getting an offsetting deduction. So basically, it’s a bad rule, but very popular, so no politician wants to change it.

    Plus, I bought a house this year, but I don’t think I’ll even spend enough to itemize, so I don’t see myself personally benefitting from it either.

  12. Comradde PhysioProffe Says:

    We have very complex tax liabilities, both federal and in many different states and countries, because PhysioWife is a partner in an entity that does business all over the country and the world. So we get our taxes done by a professional tax accountant who specializes in these kinds of partnerships. The f*cken book of tax documents we sign is hundreds of pages long, and there is no way I could ever possibly even begin to understand it. I hope that tax accountant f*cker knows what the f*cke she’s doing!


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