The Mortgage Tax Deduction Myth

Ask anyone what one of the major befits of buying a home is and you’re sure to hear many tout the benefits of the mortgage interest deduction. From your friends and neighbors to the financial gurus on TV, everyone urges you to buy a home for this sweet tax break. They can’t be wrong, can they?

It’s not that they are wrong, but like most financial rules of them, they are simply not universal truths that apply to everyone, or even most people. Unfortunately, this causes people to rush into some financial decisions without being completely informed. And when you’re talking about buying a home, it can be a very costly mistake.

The Actual Value of the Mortgage Deduction

The first mistake many people make is simply assuming they will be getting a big tax break with their new mortgage interest and property tax deductions, but that’s jumping the gun a bit. In reality, the value of the deductions is only the amount that goes above and beyond the standard deduction. You see, even if you’ve never owned a home before, you’ve been getting a pretty hefty standard deduction every year (assuming you don’t itemize). Since claiming the mortgage interest and property tax deduction requires you to itemize deductions instead, you’ll have to ensure your itemized deductions tally up to more than the standard deduction.

As a quick example, let’s say you bought a house and over the course of the year you paid $10,000 in mortgage interest and had a $2,000 property tax bill. Good news, that’s $12,000 in tax deductions right there. But guess what? In 2010 the joint standard deduction was $11,400. Assuming you had no other itemized deductions, your net tax deduction gained by using the mortgage interest and property taxes was just $600. And remember, this is a tax deduction, not a tax credit. So if you’re at the 25% tax rate you’ve only saved $150. Suddenly all of those dreams of a huge tax break go right out the window.

Of course this is just a high level example. You may have other deductions that can be itemized and your tax situation may be different which yields a bigger deduction, but this is to show you how to really place a value on the mortgage deduction. It isn’t the full amount that’s meaningful, but the amount above and beyond the standard deduction.

Why Many Homeowners Don’t Even Qualify

The other realization first time homeowners come to is that it may not even be worth claiming these so-called huge tax breaks. The reality is that you need to carry a mortgage large enough to make the tax deduction even worthwhile. Those who are buying less expensive homes or don’t need to borrow as much may find there’s really no benefit at all.

Another quick example: Let’s say you buy a $150,000 house and put 20% down and finance the rest at 5%. Guess what? In the first year you’ll pay less than $6,000 in mortgage interest. Even if you had a $2,000 property tax bill, a married couple would still fall over $3,000 short of meeting the standard deduction. So, unless you were able to come up with significant itemized deductions elsewhere you’d have no reason to claim any mortgage interest deduction.  As you can see, many homeowners who buy modest homes, especially in the low mortgage rate environment we have now, won’t even see the tax benefits that everybody loves to talk about.

The Diminishing Deduction

Even if you do qualify for the mortgage deduction there’s another caveat. Because most mortgages are front-loaded with interest, you’ll pay less and less in interest with each passing year. So, between the standard deduction amount increasing most years and the amount of interest you pay going down each year it isn’t uncommon to find that just a few years into a mortgage it’s no longer beneficial. So, keep that in mind. The deduction will diminish or be gone entirely long before the loan is repaid.

Buying a Home for the Right Reasons

So, is the mortgage deduction worthless? Not at all. The point here is that even though everybody loves to talk about the great tax breaks from owning a home, you have to look at it in context. What seems like a huge benefit is often little more than a few hundred dollars in actual tax savings, if there’s any savings at all.

The real danger is that people who aren’t aware of how this tax deduction actually works may rush into buying a home, or buy more home than they can afford simply because they think it will be offset by big tax savings. This happened a lot in the great real estate bubble. People would justify spending more on a home by talking about a bigger tax break. While on paper that may be true, spending money is spending money no matter how you look at it, and the added costs, either direct or indirect, will far outweigh any tax savings.

This is why it’s important to buy a home for the right reasons. There are many reasons why buying a home is a good idea. But doing it just for a tax break isn’t one of them.

Author: Jeremy Vohwinkle

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

14 comments
TaxguyinMD
TaxguyinMD

Article is misleading in a couple of points, as someone else points out not everyone is married filing jointly so the interest deduction and property tax deduction has a bigger effect. Secondly, once you open a Schedule A you get to deduct what you paid in state income tax that year for states that have income taxes or what you paid in sales taxes over the year in states that don't have an income tax. Combined with your mortgage interest and real estate taxes that's way more than the standard deduction. Thirdly, sure renting is cheaper than a mortgage payment in some cases but after my house is paid off, I will have a place to live for the rest of my life in my retirement without having to worry about coming up with rent, even if my house is worth nothing on the real estate market I will still have a place to call my own, rent free

RB Boren
RB Boren

Excellent post with just the right point: buy a home for the RIGHT reasons.

This illustrates what I call Tax Derangement Syndrome, a mind-altering affliction in which tax implications, real or imagined, lead to decisions which are financially suboptimal.

JCDI
JCDI

"A house purchased today needs to stand on its own as an investment."

@Kevin, I'm not sure if you meant it this way, but I don't believe owning a home is really about investing.

We didn't buy our home as an investment. We bought it for stability and location. We bought what we could afford. The fact that it has lost value, doesn't bother me, because that isn't my overriding concern.

Now, if you are buying rental properties, that is a different ball game.

:O)

Jim
Jim

The main tax savings from a house isn't that you can deduct the interest but that don't pay taxes on the "imputed rent" that you pay yourself for living there.

Jen
Jen

Hmm... So maybe I should be happy I bought in an area where home values are high? ;) I'm single, so as Big-D points out, my standard deduction is much lower. And, since the average home price in my area (Metro Boston) is around $300K, higher in my community, my mortgage is a lot more than the example. So are my property taxes. Of course, I didn't buy my condo for the tax deduction. I just get to enjoy the tax deduction a little longer :)

Also, the tax savings is offset by all the home maintenance costs. My mortgage, property tax, insurance, and condo fees all cost more than what I was paying in rent. And, in MA, you can deduct your rent up to a ax limit from your state taxes.

Further, whether you get to deduct it or not, mortgage interest is still interest, and money out the door. I just don't see the point in staying in a higher interest loan to get the deduction, or not prepaying to get a bigger deduction.

If anything, the mortgage deduction helps soften the blow of home ownership.

Kevin@OutOfYourRut
Kevin@OutOfYourRut

I did a post on this very topic on my site. The combination of lower interest rates, higher standard deductions and lower tax rates has taken much of the tax advantage away from a lot of homeowners.

The situation is even more pronounced with 15 year mortgages. Since the paydown is quicker, the interest paid can drop down and after a few years you may not even be able to itemize.

A house purchased today needs to stand on its own as an investment. Tax advantages no longer sugar coat the calculation.

camu
camu

We pay $9,000 in property taxes and $10,000 in mortgage interest (welcome to New Jersey!) so in our case it was well worth it :)

Pete
Pete

I think you make the point that a lot of people miss - yes, you can get a tax deduction. But the actual savings from that deduction in most cases isn't very large. So if you're buying a house anyway, go ahead and claim it - but don't use that as one of your main reasons for buying because it's really not as big of a deal as it is portrayed.

Big-D
Big-D

I just have a few things to say. First off, yes if you are married (which less than 50% of adults are), and have a family your deductions are higher. If you are single or head of household, your limit is a lot lower, and won't have as much to beat the standard deduction. Yes interest diminishes over time, but you get it while you can. Buying a house for the "mortgage deduction" is stupid, as you should buy a house for the fact of buying a house, and no other reason. The maintenance, taxes, etc. are all expensive and living in a place means work and upkeep (unless you pay for that stuff). I have said it before, and will say it again - A house is not an investment. People need to quit looking at it as such and realize it is a stable place for you to raise a family, live in a community, etc.

@the happy rock - donations of money/stuff to charity are schedule A deductions, and those are identical to the housing mortgage interest, taxes paid, etc. Thus it is not guaranteed like you said, it is only guaranteed if you beat the standard deduction like Jeremy said about mortgage interest.

Otherwise .. great article. I agree with the main points whole heartedly.

Elle
Elle

Great job covering the topic Jeremy! We were encouraged by friends and family to buy a home to get a tax break, but the numbers don't add up.

We bought a house that we could afford on one of our incomes, so the interest paid is less than standard deduction. We got a house because we wanted to and we were conservative on what we wanted for our first place.

The Happy Rock
The Happy Rock

Nice article Jeremy.

I see so many people just blindly believing that buying a house makes good tax sense. For most of them it just isn't true. Even if it is true, it has a much smaller impact than they think.

One the practical side, they can accomplish a guaranteed tax deduction by donating the money to charity and multiply benefit and not just throwing it to the bank.

Tony
Tony

"So in our case it was well worth it". I wonder, well worth it compared to what? You are paying $19000 in Taxes+Interest. Couldn't you rent a comparable place for less than that in New Jersey? When you add insurance, maintenance, etc. it can get really expensive

GoYanks
GoYanks

As a fellow Jersey resident, I can comment on this - A comparable place to rent would cost $24000 a year or more! So yeah, in camu's case, it may be "well worth it"!

Jesort415
Jesort415

" A comparable place to rent would cost $24000 a year or more!"
It must depend on the area of NJ. We are in the Millburn area and rent a 4 bdrm apt with laundry and a big backyard and a great school system for our kids and only pay 15k a year in rent. Taxes in this area for a small house are 10k+ so renting works for us.