clock menu more-arrow no yes

Filed under:

Mortgages may offer major tax deductions

By now, you have to face up to it. All the documents you need to do your taxes are in hand - statements from your employer, the bank, mutual funds and stock brokers and the mortgage company.

From most of these sources you're getting a record of the income you earned - from working, saving, investing and selling stocks and bonds. You have to pay taxes on all that money.The statement from the mortgage company is different. For most middle-income homeowners, it represents the most substantial tax savings available.

Consider, in the first year of a $150,000 mortgage with a 30-year term and an interest rate of 7.5 percent, you pay $11,203 in interest. Unless you have something unusual in your finances, all of that interest will be tax deductible.

If you're in the 28 percent tax bracket - the last dollars you earn are taxed at 28 percent - this mortgage interest deduction will be worth $3,136 to you. In the 31 percent bracket, it's worth $3,472. Beyond that bracket, your deductions probably are limited so you may not get the full advantage of mortgage interest.

This is the time of year you come to appreciate the 30-year mortgage. It will yield major tax deductions for years because almost all of your payments go to interest instead of principal for a very long time.

In the first year of that $150,000 mortgage, your monthly payment of $1,048 consists of a little more than $100 a month in principal; the rest - more than $900 a month - goes to interest. By the fifth year of the mortgage, you're paying $160 a month or so in principal, but the interest is still in the $800 range.

The tax savings are the main advantage of a 30-year mortgage for many households, along with the lower payments it requires.

A 15-year mortgage will provide a substantial tax break as well - at least for awhile. In the first year of the $150,000 mortgage, your interest payments are in the $900 range, just as they are on the 30-year mortgage. The difference is, your principal payments are in the $400 range.

But by year five of the 15-year mortgage, the interest payments are down in the $700 range, and the tax benefits fade rapidly each year after that.

If you can afford the higher payments on a 15-year mortgage, consider whether the early payoff and equity buildup are worth more to you than the tax deductions on a longer term loan.

Another point to consider as you do your taxes is whether you would benefit from a home equity loan or line of credit. You can't deduct the interest you pay on a car loan or a credit card or a department store bill or a tuition loan. But if you dump all that debt into a home equity loan, you most likely will get a deduction on the interest you pay, generally on any loan amount up to $100,000.

A home equity line of credit of $40,000 at 8.5 percent would mean an interest payment of $3,400 in the first year, a tax savings of $952 in the 28 percent tax bracket.

But other factors may make a home equity loan less desirable. For example, if you buy a car and charge it to the home equity line, you may be paying on that car for 15 years, long after it's out of your life. If you switch credit card debt to a home equity line, you may run up the cards again and be stuck with double payments.

Consider your habits and fiscal discipline before getting a home equity loan to pay off other debts. In some households, the tax advantage will not outweigh the drawbacks.