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the mortgage interest misconception

mortgageWe meet with a lot of people and constantly hear they are benefiting from the mortgage interest deduction on their taxes but the reality is … most aren’t. For this to make sense, you have to first understand the tax code and your tax return.

To benefit from a deduction of your mortgage interest on your taxes you must first be able to itemize expenses which allows you to deduct more than the standard deduction. By itemizing, you forgo the standard deduction, which starts at $6,350 for singles and $12,700 for couples filing jointly in 2017.

Consider this scenario …

You and your spouse paid $12,000 of mortgage interest on your home this year. You also had $3,000 in other tax deductions. If you itemize, you’ll be able to claim $15,000 in tax deductions. If instead, you choose not to itemize, you could take the $12,700 deduction for being a married taxpayer.

Thus, the net effect is that only $2,300 of your deductions makes a difference since your itemized deductions of $15,000 exceed the standard deduction of $12,700 in this situation. If you end up in a marginal tax bracket of 25%, you’ll only save about $600 in taxes on $12,000 in mortgage interest — not nearly as much as people think they are saving.

The real winner when looking at the above example is the bank because you paid them $12,000 of interest on your mortgage, you still haven’t paid it off and you probably are going to pay them $11,500 of interest next year.

Let’s take a quick look at an amortization schedule. The median home price in the US right now is $313,700. Let’s assume a 20% down payment. That leaves us financing $250,960. The variables for the loan calculator are as follows:

  • Principal Financed – $250,960 Term
  • 30 years fixed Rate – 3.85%
  • No additional principal payments.
PaymentPrincipalInterestTotal InterestBalance
$1,176.52 $371.36 $805.16 $805.16 $250,588.64
$1,176.52 $372.55 $803.97 $1,609.14 $250,216.09
$1,176.52 $373.74 $802.78
$2,411.91 $249,842.35
$1,176.52 $374.94 $801.58 $3,213.49 $249,467.40
$1,176.52 $376.15 $800.37 $4,013.86 $249,091.26
$1,176.52 $377.35 $799.17 $4,813.03 $248,713.90
$1,176.52 $378.56 $797.96 $5,610.99 $248,335.34
$1,176.52 $379.78 $796.74 $6,407.73 $247,955.56
$1,176.52 $381.00 $795.52 $7,203.26 $247,574.57
$1,176.52 $382.22 $794.30 $7,997.56 $247,192.35
$1,176.52 $383.45 $793.08 $8,790.63 $246,808.90
$1,176.52 $384.68 $791.85 $9,582.48 $246,424.22

So, in the first year, you paid $9,582.48 of interest. Now, let’s look at the first 7 years of interest. In the first 7 full years of owning your home with the current mortgage rate, the homeowner would pay $71,273.28. The interest rate on that mortgage is 3.85% on a 30-year-fixed note. Now, let’s divide the $71,273.28/$98,827.68 and we get a 72.11% of all the payments in the first seven years are interest. The banks are great at getting you fixated on the rate of interest so you miss the volume of interest you are truly paying.

Now, look at that number in view of your tax return. Let’s say your income stayed constant over that time, many Americans know they are paying interest, but think they are deducting it. In our prior example with these numbers and only $3,000 in other deductions, you would not have deducted one dime of mortgage interest against your taxes and parted ways with over $70,000 of interest.

Why did we focus on the first 7 years? Because the average American moves homes every 5-7 years. The data shows that the average American will move 11 times in their life – the average life expectancy is 77 years, so 7 years. Looking at other data it suggests every 5, which to us seems a little aggressive. Most people move around more from their college years to about thirty years of age and then slow down after that. Nonetheless, this is why 60% of Americans over the age of 60 do not have their homes paid-off.

Most Americans hear “Don’t pay off your mortgage because the stock market is a better investment” but the problem is most American’s save that money in the market in a qualified plan and cannot use that money to accelerate their loan payoff amount. If you factor in a move every decade from 25-65, property taxes, insurance, real estate fees and upgrades that need to be made to the homes, most Americans still owe on their home well into their sixties and in the process, they may not have deducted a dime of the interest along the way.

If you are irritated off right now, you should be. If you want a clear path out of this mess using a revolutionary strategy to pay your house off in 5-7 years, we would be happy to show you.