June 03, 2016
Neil Irwin has an interesting piece in the Upshot section of the NYT noting factors that people may not consider in deciding between renting and buying their home. One item I would add to the list is the tendency to overstate the value of the mortgage interest tax deduction.
It is common for realtors to push houses on prospective buyers by telling them that their mortgage interest is tax deductible. This is true, but the value of the deduction is only equal to the difference between the household’s deductions including mortgage interest and the standard deduction.
Most people will have few deductions other than their mortgage interest deduction. Typically, they may have state income taxes, and that will be pretty much it.
Suppose these taxes come to $5k a year for a couple and their mortgage interest is $10,000 a year. If they are in the 25 percent bracket, they might be inclined to think that they are saving $2,500 a year from their taxes due to the mortgage interest deduction. In fact, since the standard deduction for this couple is $12,600, they are only benefiting to the extent that the mortgage interest deduction puts them above this number. In this case their combined deductions are now $15,000, which is $2,400 above the standard deduction. That will save them $600 a year on their taxes, not $2,500.
Furthermore, as time goes on, interest will be a smaller share of this couple’s mortgage payment as the mortgage is gradually paid off. This will reduce the amount that can be deducted against their taxes. This means that the mortgage interest deduction will be of less use to this couple over time.
Many homebuyers are unaware of these facts, these realtors can be misleading. They are worth keeping in mind by potential homebuyers.
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