With all the recent talks about tax reform, many of you have heard talks about the mortgage interest deduction being removed as a deduction for individual tax returns. I wrote this to let all of you know what that means and how it can affect both the real estate market and our income taxes. Below are two excerpts of an article that I completely disagree with, but I wanted to give a reference and insight on the argument for the removal of the deduction.
Many Homeowners Get Nothing
According to data compiled by the 2005 President’s advisory panel on federal tax reform, only 54% of taxpayers who pay interest on their mortgages receive a tax benefit. That leaves a hefty 46% of homeowners paying interest, but receiving no benefit at all. Even those who do receive a benefit are likely to receive far less than they expect.
A Better Way
Rather than spending large amounts of money on interest for little in return, you will be far better off paying cash for your new house. A cash purchase will save you tens of thousands of dollars because you will not be paying interest. (This may be the biggest debt you’ll ever incur. Learn why you should retire it sooner rather than later, in Paying Off Your Mortgage.)
Of course, there’s always the argument that you could make more money by paying the interest and investing the rest of your money in the stock market. It seems like a great strategy when the market is going up, but prognosticators giving that advice are nowhere to be seen when the stock market drops 40%, home values fall 40%, and their investment advice leaves homeowners owing more on their mortgages than the home is worth.
Since there is no investment out there that will guarantee better returns than the amount you would save by avoiding interest payments altogether, the conservative choice is
clear. Avoid making interest payments if you can. Pay the house off quickly if you cannot.
I don’t agree with the article in its entirety, but I understand how the author came up with their conclusion and advice. I disagree because I live in California where the home median cost is one of the highest in the nation. According to Zillow as of 8/30/17 the California median home price is $505,800 and they’re expected to rise an additional 2.4% within a year. So, if you’re buying or own a home in California losing that mortgage interest deduction really is a big deal. Anyone purchasing a home in this current real estate market and who finance would lose out on a huge tax benefit.
Let’s say a couple in their mid-thirties with an average income of $130,000 decide to leave their $2,500 a month Los Angeles apartment. If they decide to purchase a $500,000 condo, and they have a 20% down payment to avoid Private Mortgage Insurance (PMI), they can expect a monthly payment of $2,684.11 including principal and interest. Property taxes are an additional $520.83 a month. That’s a total of $3,204.94 per month.
I’ve compiled a table which shows the total interest paid for this example and ran it through my financial calculators to show the total tax savings. The numbers should prove that a mortgage interest deduction is crucial for many working Californian Residents.
If you look at the first Calendar year, assuming they purchased the home in January 2018, they would pay a total of $24,487.24 in mortgage interest for that year alone and approx. $6,500 for state and local property taxes.That is A LOT of interest, but, they’re allowed to take a deduction that is over the standard deduction amount for a couple. The attached tax summary shows the differences the mortgage interest deductibility. The total federal tax on their $130,000 income would be $16,843 if they had no children and their California State tax would be $5,372 based on 2016 income tax rates. We can now see the difference when we’re allowed to deduct the mortgage interest and the property tax. Our tax post deductions would be $12,661 Federal and $3,358 State. This means that this couple would have a combined tax savings of $6,196. That’s 516.33 a month!
If you have any questions please give me a call and we can schedule an appointment to discuss how purchasing or selling a home instead of renting can benefit you.