March 17, 2012 |Brent Hunsberger, The Oregonian
Readers have asked lately about a couple of always-touchy subjects: debt and taxes.
Not the most pleasant of subjects, perhaps, but let’s dive in.
Ed Sage of Portland writes: I feel as though it’s a myth that you should keep a mortgage around so that you can itemize the interest. To itemize at all, a family needs most of the deductions on Schedule A. If we were to pay off our mortgage, we would most likely do better by taking the standard deduction. In the meantime, we’d SAVE thousands and thousands of dollars not paying interest! Isn’t this correct?
My answer: Yes, but that’s the wrong comparison to make, says Joe Alfonso, a fee-only certified financial planner and licensed tax consultant at Aegis Financial Advisory in Lake Oswego.
First, the mortgage deduction should not drive a decision on whether to buy a home or to refinance. It’s true that a $250,000, 30-year fixed mortgage with an interest rate of 4.25 percent will cost $192,746 over the life of the loan — far more than the tax savings on the deduction itself.
And at some point, the total annual interest payment on a mortgage will fall below your standard deduction.
But the deduction can definitely come in handy for many homebuyers. So, for that matter, can a mortgage.
Buying a home a little bit at a time allows you to spend or save your income elsewhere. Say you’re investing $400 a month for 30 years, or $144,000 total, in something that earns a 6 percent annual return. You’ll end up with just more than $400,000. That wipes out the cost of the previously mentioned mortgage.
“I see the mortgage interest deduction as icing on the cake,” Alfonso said. “The bigger advantage is the free cash flow. Or, what’s the best and highest use of your money?”
A low, fixed-rate mortgage also protects you if inflation soars and money becomes more expensive to borrow, he said.
Before paying off a mortgage, you should pay off high-interest credit cards and any auto loan, which charges interest that isn’t deductible, says John Wyckoff, a certified financial planner with StanCorp Investment Advisers in Portland.
Younger adults, he said, should make sure they’re contributing to 401(k)s, Roth IRAs and even college savings plans before making extra mortgage payments.
“In the current low-interest rate environment, it may be better to refinance a high-rate loan with a low, 3 percent, 15-year fixed rate mortgage and pay off the mortgage over time while funding retirement accounts,” Wyckoff said.
From a tax perspective, the mortgage-interest can be quite valuable to a couple with no kids, a single person buying a home and to many families. Annual interest payments can easily total more than the annual deduction for a couple ($11,600 in 2011) and most singles ($5,800 in 2011).
What’s more, the deduction for real estate taxes adds several thousand to that total.
Wealthier taxpayers hit by the alternative minimum tax have to give up some deductions as a result. The mortgage-interest deduction isn’t one of them. “It’s the biggest deduction a lot of them have,” Alfonso said.
In addition, without the larger mortgage deduction, most taxpayers cannot benefit from the charitable deduction, which must be itemized. It also allows them to claim deductions for state income taxes and sales taxes.