I recently read a blog from the Wall Street Journal, “12 Debt Myths That Trip Up Consumers“. It includes many great tips, leading with the best: “Avoid debt.” But then toward the end, it stumbles badly with this one:
Mortgage-interest payments can be deducted on your tax return, which can save you a bundle.
The math here just doesn’t hold up. Yes, if you have mortgage interest, deducting can save you a bundle over not deducting it. But the implication that you should not pay cash for your home because you’ll lose those “savings” is a shell game. Not paying mortgage interest in the first place will save you more than deducting the mortgage interest you have paid as long as your tax rate is less than 100% — that’s the math in question.
- Starting assets $100,000, mortgage interest payments: $1,000, tax rate 50%, tax bill of $2,000 reduced by $500 to $1,500, ending assets $97,500.
- Starting assets $100,000, no mortgage interest, no deduction, tax bill of $2,000, ending assets $98,000.
- $97,500 < $98,000. QED.
You may not be in the position to avoid mortgage interest payments, but if you are, make sure you do the fuller calculation before you pay a lot of money in order to save a little.
—jhunterj
The $500 gap in your example makes the cost of paying interest pretty clear. When you say to do the fuller calculation, would you include the cash reserve left after buying outright, or keep that separate from the deduction comparison? A buyer could come out ahead on the tax math and still have very little cash available. That seems like a useful distinction.
Disclosure of interest: I help build this receipt maker.
Agreed, an even fuller calculation would include interest on the cash reserves or other opportunity income or can generate, as well as asset appreciation on the house.