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plus it's tax advantaged I've never really liked that reasoning. Let's assume that someone is in the 30% tax bracket (paying 30% on all qualified income). Let'

plus it's tax advantaged I've never really liked that reasoning. Let's assume that someone is in the 30% tax bracket (paying 30% on all qualified income). Let's say this person makes $100,000/yr. They pay $30,000/yr in taxes. Let's say they also have a $100,000 mortgage at 5% APY. They're paying $5,000/yr in interest. That interest is deducted from their income of $100,000 leaving $95,000 taxable income. Assuming they didn't move down a bracket, they're paying $28,500/yr instead of $30,000/yr, saving them $1500/yr in taxes. Remember though that they're paying $5,000 in interest. It doesn't make financial sense in that respect. They are paying $3500 more per year than if they paid off their mortgage. It's seems like a way for people to live in nicer houses (or have more of them) and get a "deal" or "discount" on taxes, though in the end they are paying more. This doesn't take into account housing prices, cash flow issues, or alternative investments. The rational I've seen in people who could pay off their houses but decide not to is either: A: I can use this as leverage and sell later when the price is higher, making me money (risky, if the market drops) B: I can use the money that I could use to pay off my mortgage to invest in other things (also risky, given the nature of any investments) or C: It's a tax deduction (which from my math doesn't make sense. Maybe someone can show me a situation where the math works out better by keeping the mortgage)

mattmaroon 18y ago
I'll show you the situation. If your mortgage is at 6% (I think mine is just below that) and you're in the 30% bracket (I am around there) you're effectively saving 1.8% in deductions (30% of the 6%) and therefore paying 4.2% interest right? A C.D. now pays over 5.25%. So to clarify the math, you borrow $200k, pay $12k in interest, but get to deduct it and therefore save $3.6k, thus really paying $8.4k in interest (or 4.2% of the $200k). Therefore if you mortgage the house (as opposed to buying it outright) and buy into a CD at 5.25% you're effectively gaining 1.05% interest for free. You're making about $2k a year. Also you're increasing your credit score, which saves you a lot of money in the long run. In your above scenario the guy was saving 30% of 5% (1.5%, or 1500) which would put him at 3.5%. He'd be borderline retarded to pay for the house outright. Much more intelligent (especially for someone my age, who has a good 30 years to worry about retirement, thus reducing the volatility) is to put that $200k into the market, which will probably average somewhere between 7-10% in that time. Suddenly that $200k mortgage turns into a shit ton of money in my retirement account. Also, there's the fact that the mortgage costs only slightly more than renting a similar place (if homes as nice as mine were available for rent, which they generally aren't here) yet in 30 years I have a free and clear home I can sell. In summation, mortgages FTW. That's why very wealthy people who could afford not to still damn near always get them.
- ksvs 18y ago
  You forgot to deduct the income tax from the interest generated by the CD.
  - mattmaroon 18y ago
    True, that's because I'd sooner invest in stocks and only pay capital gains.
- dkokelley 18y ago
  So, in essence you're in favor of option B (use the money to invest in something that will net you more in the end), specifically in CDs, or possibly a money market account. Thanks for bringing that up. The CDs are FDIC insured and are a strong case for not paying off the mortgage.
nostrademons 18y ago
The tax deduction on mortgage interest just means you cut the interest rate by the tax bracket, eg. if you're in a 33% tax bracket and have a 6% mortgage, the effective interest rate is 4%. Makes the math easy.
dionidium 18y ago
In addition, it seems to me that a lot of middle-class homeowners who use this argument would be just as well off (or very close to it) with the standard deduction. I've never owned a house. Am I missing something? EDIT: I live in the Midwest where 2000 sqft in a nice neighborhood is very often less than $200k. This is probably a factor.
bp001 18y ago
Agree dkokelly, and it also gets worse. In your example, $5000/year interest is under the standard deduction. Unless you already have other deductions to itemize, you are getting no tax write-off for the $5000. For instance, in 2008, the standard deduction for singles is $5450. Lets assume that you have $2000 in other itemized deductions. So, the first $3450 of your mortgage interest simply offsets the write off you would get with the standard deduction. Therefore, only $1550 would get you an additional deduction. Now, if you're married, the standard deduction is $10900. In my situation, my mortgage interest is just barely greater than that amount.

mattmaroon 18y ago

I'll show you the situation. If your mortgage is at 6% (I think mine is just below that) and you're in the 30% bracket (I am around there) you're effectively saving 1.8% in deductions (30% of the 6%) and therefore paying 4.2% interest right? A C.D. now pays over 5.25%. So to clarify the math, you borrow $200k, pay $12k in interest, but get to deduct it and therefore save $3.6k, thus really paying $8.4k in interest (or 4.2% of the $200k). Therefore if you mortgage the house (as opposed to buying it outright) and buy into a CD at 5.25% you're effectively gaining 1.05% interest for free. You're making about $2k a year. Also you're increasing your credit score, which saves you a lot of money in the long run. In your above scenario the guy was saving 30% of 5% (1.5%, or 1500) which would put him at 3.5%. He'd be borderline retarded to pay for the house outright. Much more intelligent (especially for someone my age, who has a good 30 years to worry about retirement, thus reducing the volatility) is to put that $200k into the market, which will probably average somewhere between 7-10% in that time. Suddenly that $200k mortgage turns into a shit ton of money in my retirement account. Also, there's the fact that the mortgage costs only slightly more than renting a similar place (if homes as nice as mine were available for rent, which they generally aren't here) yet in 30 years I have a free and clear home I can sell. In summation, mortgages FTW. That's why very wealthy people who could afford not to still damn near always get them.

ksvs 18y ago
You forgot to deduct the income tax from the interest generated by the CD.
- mattmaroon 18y ago
  True, that's because I'd sooner invest in stocks and only pay capital gains.
dkokelley 18y ago
So, in essence you're in favor of option B (use the money to invest in something that will net you more in the end), specifically in CDs, or possibly a money market account. Thanks for bringing that up. The CDs are FDIC insured and are a strong case for not paying off the mortgage.

nostrademons 18y ago

The tax deduction on mortgage interest just means you cut the interest rate by the tax bracket, eg. if you're in a 33% tax bracket and have a 6% mortgage, the effective interest rate is 4%. Makes the math easy.

dionidium 18y ago

In addition, it seems to me that a lot of middle-class homeowners who use this argument would be just as well off (or very close to it) with the standard deduction. I've never owned a house. Am I missing something? EDIT: I live in the Midwest where 2000 sqft in a nice neighborhood is very often less than $200k. This is probably a factor.

bp001 18y ago

Agree dkokelly, and it also gets worse. In your example, $5000/year interest is under the standard deduction. Unless you already have other deductions to itemize, you are getting no tax write-off for the $5000. For instance, in 2008, the standard deduction for singles is $5450. Lets assume that you have $2000 in other itemized deductions. So, the first $3450 of your mortgage interest simply offsets the write off you would get with the standard deduction. Therefore, only $1550 would get you an additional deduction. Now, if you're married, the standard deduction is $10900. In my situation, my mortgage interest is just barely greater than that amount.