The Fallacy of Mortgage Interest Deductions

I heard a complaint about the new IRS forms for Mortgage Interest Deduction for 2013 was going to be published late.  It seems that 2013 is not a year of peak efficiency over at the IRS. but I digress.

I suggested that the homeowner probably wouldn't have the opportunity to use the form anyway because they were married and the standard deduction would be bigger than their itemized deductions, of which mortgage interest is included.  What?

This means that the mortgage interest on your home is not going to do anything to lower your taxes because the government's standard deduction is bigger than your mortgage interest benefit.

I'm not an accountant, so please check with your accountants, but this short interaction made me realize the fallacy of sales pitch of interest deduction.  We've all heard it: "go ahead and take the loan, you can afford it, make it 30 years, you can deduct the interest."  It's a romantic and emotional argument that pulls on our justifications for buying a house.

But wait, Congress wants you be a homeowner, or they wouldn't have given us the deduction.  Wrong.

Congress may want people to be homeowners, but their math is so far away from this conclusion that it should be clear to you as a (potential) homeowner that Congress is not and has not made an effort for you to use a mortgage to encourage home ownership.  In the old days, all interest was deductible because it was considered a business expense.  This is a holdover from way back when.

Let's say you take a loan at $200,000 for 30 years at 5%.  The total interest on this loan in the first year is going to be just under $10,000.  yup.  the math is not in your favor, but let's save that argument for another time, shall we?

Couples filing jointly in 2013 is $12,200.  This means you need to have a little more than $2,000 in other expenses, think medical, to jump over the $12,200 standard deduction.  Odds are, most couples won't qualify for this.  Remember that the circa $10k interest only applies for the first year of the mortgage and (hopefully) yours will get smaller every year.  At some point, even if you do qualify now, you won't soon.

The silver lining? Single people.  Single homeowners can benefit from this for quite a few years, because their standard deduction is much smaller: $6,100.  But come on, how many single people are home owners?  Not that many.  If you are: Great! You should itemize your taxes.

The first lesson is if you are a married couple and your total mortgage will be $200,000 or less, don't let the mortgage guy sell you on the tax benefits.  They are probably not there.

The conclusion here is that we should not be emotionally swayed by the argument that deducting your mortgage interest is good for your financial health.  It really isn't.  What is good for your financial health is to put down a bigger down payment and pay down your debt. 

Getting a loan that maximizes your potential tax deductions probably also maximizes your total interest paid.  You'll be in more debt for a longer period of time.