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Thursday, August 24, 2017

Don't Be Scared By The Possible Loss of Mortgage Interest Deduction

Talk of tax reform has impacted the stock market.  Whenever politicians in the highest offices, including our President and Speaker, talk tax reform (a euphemism for tax cuts) the market bounces up or down.  If the comments made hint at the tax reform (cuts) process taking shape sooner than later, the market rallies.  If the comments are vague about when and if Congress can get started on the process, the market sells off.

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Homeowners have been worrying about their ability to deduct mortgage interest from their taxable income.  The Donald has not ruled it off the table.  His tax plan, however, calls for an increase (almost double) in the "Standard" deduction so fewer homeowners would need to use the MID (Mortgage Interest Deduction).  Many people are confused and quite irritated by the potential changes.  After all, they were sold on the perk of being able to deduct all of their mortgage interest from their taxable income and thus save on taxes.  But this was simply a selling gimmick used by their realtors.

You Don't Get A Dollar for Dollar

Many homeowners erroneously believe they can get a tax savings from all of their mortgage interest.  That's just wrong.  Your marginal tax bracket determines how much of your deduction you can apply to lower taxable income.  The lower your tax bracket, the lower the tax break you'll get.  Someone in the 25% tax bracket, let's say, that pays $12K in mortgage interest can apply $3,000 to be excluded from taxation.  In 2017, the standard deduction for a married couple filing jointly was worth $12,700.  25% of this is $3,175.  In this example, you'd be better off taking the standard deduction by $175 in tax savings.

According to Taxpolicycenter.org, about 70% of U.S. taxpayers elected to take the standard deduction.  Why?  They most likely didn't have enough deductions to itemize and reducing their tax liability via the standard deduction made more sense.  I also personally think that many Americans have no idea what's going on when it comes time to file their taxes.  They take their W2's and maybe a mortgage interest statement or two, and drop them off at the nearest Liberty Tax.  They go in for their follow-up and are told they'll get back about $3K (the average) in refunds and jump for joy, not knowing where it came from.

So, only 30% of all U.S. taxpayers would be "affected" by a change in policy on the M.I.D.  And out of this 30%, those who would be most affected are...

Top Income Earners In Top Real Estate Markets

In order to benefit from the M.I.D. you actually have to belong to a select group of taxpayers.  First, you have to make income upwards of $100K a year.  So we're talking high paid professionals and entrepreneurs here: doctors, superintendents of schools, lawyers, successful business owners, etc.  Also, you have to be in a high tax bracket, as in anywhere beyond 25%.  Finally, you also need a McMansion or San Francisco 1-room flat type of mortgage, meaning close to a million dollars and being somewhere at the start of your amortization schedule.

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It makes perfect sense.  High income earners that are employees with little if any deductions from assets, meaning they make their money actively and not from passive sources (real estate, e.g.), will generally have higher income taxes.  According to The Motley Fool the average American's mortgage for First Time Homebuyers is $190K.  What they pay in mortgage interest depends on their interest rate, of course.  Interest rates on mortgages have been historically low for several years so we can assume many newbies (less than ten years) to home ownership will not pay enough mortgage interest to offset the savings they'd get in taxes by taking the standard deduction.  Even if you throw in property taxes into the mix!

So ending the Mortgage Interest Deduction will not destroy home ownership.  It can affect the housing market, however, especially in the first few years of the change.  Why?  It will take time for the average American to understand they're not really losing something sacred.  Buyers may be scarce, thus ending the housing boom.  Property values may fall.  A recovery will ensue once Americans realize they had a bad deal to begin being homeowners, and head back into the market, buying homes again mainly to build equity the old fashion way: by paying down principal.

The change may be more dramatic at the high end.  Financing the purchase of a million (or more) dollar home would be a serious sucker's game.  To put it bluntly, you will be screwed!  If you're wealthy, you'd be better off paying the home outright, and avoiding a mortgage altogether.  The same can be said of middle-class buyers.  Pay-off your mortgages as fast as you can.  It's in your interest to kill the interest!

Thanks for reading!  Until next time.

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