The Fallacies of the Mortgage Interest Deduction

mortgage interest and principle

Mortgage Interest Principle – For many taxpayers the mortgage interest reduction is a crucial tax deduction. The mortgage interest paid on an once a year basis regularly permits taxpayers to benefit by trying itemized refunds rather than the yearly standard deduction.

Coded Section 163(h)(3) allows taxpayers to deduct mortgage interest which is paid during the tax year on the acquisition or home equity indebtedness with their primary residence. This is truly a blessing to many taxpayers who would not residence. This is actually a home without such a tax benefit. The mortgage interest amount usually is a home without this sort of the itemized deductions.

Other itemized deductions include, but are not limited to, state and local taxes paid (state income tax, personal property tax, ad valorem tax, real estate taxes, etc.), medical expenses, charitable donations, investment advisory expenses and unreimbursed employee expenses. The combination of the itemized deduction is usually greater than the standard deduction (for 2008: $5,350 for single or married filing separately, $7,850 for head of household and $10,700 for married filing jointly).

Many taxpayers generally larger than the standard deduction is the entire amount. However, the true benefit is much lower. A more realistic measure to value the actual benefit the taxpayer receives is the difference between their itemized deductions less their standard deduction multiplied by their average tax rate.

A traditional mortgage amortized over 30 years is financially structured to pay more pragmatic measure to worth the first 20 years (assuming a loan is The payments are the same amount each month, however, an important concept to understand is the interest portion decreases over time and the principle portion increases over time.

Generally speaking, a taxpayer’s income rises over their life time. Even if the taxpayer’s income rises at the annual rate of inflation, the actual dollar amount will increase. This result in higher income levels over time subject to tax. For instance, if you currently earn $40,000 a year and over 30 years you receive an annual raise of 3% you will earn just over $98,000 in 30 years.

When combining these two trends, a taxpayer’s tax deduction for mortgage interest is decreasing over time and their revenue is increasing over a period of time. The two trends result in a worrying conclusion : when the taxpayer’s wages are the lowest, the deduction for mortgage interest is the highest; and when the taxpayer’s wages are the highest, the deduction for mortgage interest is the lowest.

The US taxation system is presently a progressive taxation system suggesting the higher your taxable earnings the higher your average tax rate is. The mortgage interest deduction allows for a large deduction when your taxable revenue is low and thus subject to lower taxation rates ; and most likely increases your tax as your earnings increases over your life time and thus subject to higher tax rates.

It is likely the tax rules and regulations will change over a period of time. However, this is an oversight by many taxpayers who have not incorporated the monetary aspect and long term view of the mortgage interest deduction.

The mortgage interest deduction seems simple enough, but when you add in the long-range view and financial parts it becomes more complex. We endorse deliberating any questions with your tax advisor.

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