The Mortgage Interest Tax Deduction: Not What You Think!

Got it? Might as well use it.  The mortgage interest tax deduction, that is.  While it’s not going to change your life, it will save you a few hundred dollars on your tax bill, on average.  What, not what you were expecting?  Thought the mortgage interest tax deduction was going to spur you to wealth and forever financial security?  Think again.

Mortgage Interest Tax Deduction: the Real Story

In fact, most people believe the mortgage interest tax deduction is the Federal Government’s way of encouraging home ownership.  Nope!  Realtors may want you to believe the mortgage interest tax deduction is going to change your life (“go ahead and buy a house: you’ll get to claim the mortgage interest tax deduction!!”) but in reality this tax deduction has little nor absolutely no bearing whatsoever on people’s decisions on whether to buy a home.

If you make between $40,000 and $75,000, according to a study done by economists at the University of Pennsylvania,  you will save about $50 per month by claiming the mortgage interest deduction.  Wow, what a difference!  Good thing you took out that $200,000 loan!

Now, if you make a quarter of a million dollars a year you’ll save ten times that amount: $500 per month saved by claiming the mortgage interest tax deduction.  So now once again we have a tax code that favors the wealthy.

It’s for this reason that many people are in favor of getting rid of the mortgage interest tax deduction altogether.  Britain did in 2000.  There is almost no evidence that this tax deduction encourages people to buy homes.  I have bought three homes in my lifetime and not once did I even consider the mortgage interest tax deduction.  Not once!

Bigger Loan, Bigger Tax Deduction

The bigger loan you take, the more you get to deduct.  If anything, the mortgage interest tax deduction encourages people to borrow more than they should.  That’s why realtors love the mortgage interest tax deduction.  What’s more, the deduction is valid for home equity loans, too.  Take out a huge HELOC and deduct away, baby!

Perhaps the mortgage interest tax deduction even contributed to the real estate bubble and the financial crisis The mortgage interest tax deduction is figured into the price of homes, did you know that?  Yes, the prices of homes on the market are higher than they would be if there was no mortgage interest tax deduction.  Let me say that again.

the mortgage interest tax deduction makes home prices higher

So, for people who pay off their mortgage or who are financially responsible and borrow just what they can easily manage and pay off quickly, the mortgage interest tax deduction is not quite fair.

Home Ownership Not Affected by the Mortgage Interest Tax Deduction Because that’s Not What it was Originally Intended to do Anyway

The US income tax was first levied in its current form in 1913.  There were tax deductions, and one of them was interest.  Interest in general.  Interest was considered a business expense and mortgage interest just got lumped in with all the other types of interest, which were more business-related usually.  What!  Nope, contrary to popular belief the mortgage interest tax deduction is not Uncle Sam’s way of helping Americans buy a home.

in fact, the mortgage interest tax deduction costs Uncle Sam about $1 billion a year!  If the IRS had a mortgage interest tax credit instead of a deduction they would save lots of revenue.  This is actually a current proposal right now.  It would be more fair and it would bring in more money to the US Treasury.  Alan Viard, of the American Enterprise Institute, is a supporter of this idea, as is the Center on Budget and Policy Priorities.

So there you go folks: the mortgage interest tax deduction is not what it’s cracked up to be.  Don’t let realtors trick you into believing it’s going to save your finances when you take out too much loan to buy a home that’s too big for you.

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