Everyone is told that the tax you pay on your home is tax deductible. Back in the hayday of lending often times people would get an interest only loan and live in their “tax shelter.” Well the standard deduction for a married couple in 2009 will be $11,400. That’s an average of $950 a month.
So basically the government is already covering the first $950 worth of interest per month whether you’re paying it or not. The government is covering $5,700 a year or $475 per month if you’re filing single. So it’s not until you’re paying more than $950 a month in interest that you start getting more money back. And because it’s a deduction and not a credit you’re only going to see about 15% of that interest back at the end of the year.
If you get a $200,000 loan at 7% you’ll be paying about $11,400 or more per year for approximately 10 years assuming you pay the minimum due every month. In the first year you’ll pay about $13,936 in interest. Subtract 11,400 that you would have gotten anyway leaves you with an additional $2536 in tax deductions. 15% of that is about $380.
So because you focused on the tax deducation to try to save money you wound up with a whopping $380 in the first year of having your loan. And that amount decreases every year as you pay off your loan until about 10 years later you end up below the standard deduction so the interest you’re paying on your house does nothing to reduce you tax liability.
Now, let’s compare that to the savings you see by paying more on your mortgage than you need to. Let’s take the $32 per month that you saved on your taxes and apply it monthly to your mortgage.
Keep in mind that going the full 30 years of paying your mortgage will result in $279,017.80 in interest. Minus a few thousand in tax savings.
With an extra $32 per month put on your mortgage every month you end up paying $254,333.48 in interest and cut down the time it takes to pay off your loan by about 2 years. That’s a savings of almost $25,000 over 28 years which works out to $74 a month. Minus the $32 dollars a month extra you were spending you end up with an overall savings of $42 per month or about $504 per year.
Significantly better than trying to use your house as a tax shelter.
In my situation I have about $78,500 in interest left to pay on my home in the 10 years left to pay it off. If I were to make the minimum monthly payment I’d have 27 years left to pay and end up paying $190,770 in interest. So I’m saving $120,000 in interest.
I’d have to sell my home in less than 7 and a half years to avoid paying more interest than I would just paying off the house quickly. And in 7 and a half years I wouldn’t own the home. By being smart with my money in 10 years (only 2 and a half years later) I’ll own the home outright. When I sell I get to pocket everything.
Deductions will never make up for paying off debts as quickly as possible. A lot of people pay the minimum on their home mortgage and if they manage to pay it off in 30 years they’ll end up having paid 2-3 times what they price of the home was. So now you have to sell your $150,000 home for $450,000 just to break even.
But a lot of people don’t think about that. They just ignore the amount of money they’re throwing away in interest and in 30 years think they came out ahead when in reality they could very well have lost money on the home. In 10 years I’ll have paid about $240,000 for a $160,000 mortgage and own my home. So in 10 years anything abive $240,000 is pure profit on the home.
In 30 years it would have cost about $380,000 for a $160,000 home which means I end up with $140,000 less than if I had paid it off quickly.
That’s a lot of money lost because you forgot to consider the interest you’re paying on your home.
