Home Interest

Being tax day, I thought it would be nice to post on a tax topic.  Before you stop reading, this won’t be about teaparty, flat tax, fair tax, or the royal wedding.  On the contrary, I would like to talk about working within the system we have.

For a long time the push was to get a mortgage.  The idea was that you could get a mortgage, get a tax deduction and make money when you sell the house. (Almost no matter how long you lived there.)  The reason was that home prices increased so fast that the home’s value would increase quickly to recover the closing cost on the house.  But that whole issue is for another day…

The issue I want to discuss is the tax deduction.  If you own a mortgage in the United States, you are allowed to take a tax deduction on the interest spent on the mortgage. 

The first issue with this is the misconception about what a tax deduction is.  A tax deduction does not mean you get the money you can deduct.  It simply means you are not taxed on it. A tax credit on the other hand is an amount that will directly reduce your tax bill.  Therefore, people often times think that having a mortgage is good because of the deduction.  But the problem is that you still have to pay the interest on it.

This leads me to next problem.  If the mortgage is considered an investment, which they once were, the increase in value of your house must be greater than the interest you pay on the mortgage.  Let’s look at an example.

If you buy a$150,000 house at 5% interest, the first year of interest would cost about $7,450.  Plus the sunken closing cost around $4,000.  In order to sell your house for profit, after one year, the house would have to sell for $161,450 or 7.6%!  Not likely in today’s housing market.

This example didn’t take out the savings you would have for the reduction of taxes, but I encourage you to look at you previous return to see the net effect of the interest you paid on your tax bill.  (Spoilier! It comes nowhere near the interest expense.)

However, if you don’t have a mortgage and you don’t have cash to pay for a house outright, what do you do?

Now obviously if you rent house, you won’t own any of it.  EVER.  However, if your life is unstable and you don’t know if you can live in a place for long, it may be a good idea to rent.

So, if you choose to buy a home and don’t think you’ll stay longer than five years or so, consider your home an investment where you won’t lose ALL your money.  If you pay a dollar, you may make $0.95 back on it.  But if you’re able to stay in that one horse town for a while you could make $1.05.