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It may be interesting to realize that the government is putting out all sorts of schemes and incentives just to get the average American interested in acquiring property. Most of the time these perks come in the form of tax deductions. Sometimes however, we tend to get carried away with such treats that we don’t even realize the real danger of what we’re getting into.
Take for example, mortgage deduction. Many Americans get so thrilled by the fact that the government is allowing a deduction on their taxable income. This totals to the amount of interest paid on the loan on their home residence. Initially if you think about this, if you were paying $1,200/month in mortgage interest for a year, then some quick math will tell you that you’ll get about a $15,000 deduction. But is this really the case?
The Standard Deduction
For those who are still unaware, the government actually allows a standard deduction. For married couples, this is deduction is $11,400. The thing is, you will only get a tax deduction from the difference between your mortgage deduction and the standard deduction. So if you were entitled to a $15,000 deduction on mortgage, then in fact, you will only be getting a measly $3,600.
To put it in a more general sense, you would have to pay at least $950 per month in mortgage interest (remember, just interest and not including the principal), in order to actually realize any tax benefit from your mortgage payment. In reality this tax deduction would only be helpful if your mortgage was $200,000 or more. Any amount less than that would be almost pointless.
Now if we really think about what’s happening here, you’re actually paying more in interest than what you’ll save on taxes. This is what some people don’t really seem to realize. Let’s say you’re entitled to a $15,000 tax deduction. This does not mean that you will be paying $15,000 less on taxes. Instead, this amount will be deducted from your taxable income.
For example, you’re in the 25% tax bracket. If you’re paying $20,000 in mortgage interest, you will get a savings of $5,000 in taxes. It seems as if that you are actually paying $15,000 just so you will be eligible to get a tax deduction of $5,000. This of course isn’t so smart now that we see the numbers.
Realizing the Risk
Unless you can really afford the home, trying to keep a mortgage payment that you can hardly afford is very risky. In the unfortunate event that you lose your primary source of income, what you would normally consider as your greatest asset can in fact turn on you to become a liability. This is especially true when the housing bubble collapsed in 2007. Many people were forced to foreclosure and out of their homes because they couldn’t keep up with the high mortgage payments.
One sign that people aren’t ready to buy a home is when they try to scrimp and save on every dollar while rationalizing why owning a home would be reasonable even if they know they can’t really afford it. A mortgage deduction is hardly a good reason to get yourself into a mortgage, and in fact, you’ll end up paying more than what you hoped to save in the first place.
Mortgage deductions can be a great thing, don’t get me wrong. But it is only good for those who really have the intention to buy a home in the first place, and for those who really have the money to afford home ownership plus all the hidden expenses associated with it.
What other bad reasons are there for purchasing a home?
retirebyforty> Mortgage interest deduction is a great thing for home owners, but it shouldn’t be THE incentive to buy a home. A home is a place to live in and build a family and that should be the main focus. Another bad reason to buy a home is for “investment,” but that will take a whole post to write about.
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.