Backwards Thinking on Mortgage Interest Deductions
For most Americans who have a mortgage, interest paid on their mortgage will likely be one of their largest tax deductions. Misunderstanding this deduction is common and often leads to poor decisions.
The mortgage interest deduction will reduce your taxable income. This means that the taxes you pay will be based on a smaller amount. It does not mean that your taxes will be reduced by the amount of mortgage interest that you pay. This is a huge difference and one that you must understand.
Let’s assume that you’re in the 25% tax bracket, which means that your joint income for your household is between $63,701 and $128,501 for 2007. If you paid $15,000 in mortgage interest for the year, you could deduct that full amount from your taxable income for the year. That would lower your income taxes by $3,750 ($15,000 x 25%). Thinking about this another way, for every dollar you spend in mortgage interest, your tax bill will be reduced by 25 cents (for those in the 25% tax bracket).
I have a friend who was boasting about how much he had paid in mortgage interest for the year. He was excited to have such a large deduction at tax time. While you should certainly take full advantage of deducting all of your mortgage interest, realize that you would be much better off financially if you didn’t have to pay the interest at all. Paying a dollar to save 25 cents is a losing proposition.
For most homeowners, having a mortgage is a necessary reality which allows them to achieve the American Dream. A house is generally a person’s largest asset as well, definitions from Rich Dad, Poor Dad aside, and a responsible means to grow your wealth. We here at Lending Club want you to keep in mind that paying off your mortgage as quickly as possible can generally help your situation. Being content to make a regular mortgage payment even if the means to overpay exist, for the sake of the perceived tax break, is not a smart way to go.