The largest debt many Americans will take on in their lifetime is their mortgage debt. One tax benefit exists that can help some homeowners take at least a small bite out of their interest burden, but its actual benefits are extremely limited for most Americans.
The Mortgage Interest Deduction allows U.S. homeowners to deduct interest payments on mortgage loans up to $375,000 for married taxpayers filing separately. Here’s a look at how the deduction works for a standard $250,000 mortgage.
The Mortgage Interest Deduction Numbers
The average fixed interest rate on a 30-year mortgage is 3.96%, according to Bankrate.com. Over the 30-year course of a $250,000 mortgage, a homeowner will pay $177,601 in interest alone, roughly $5,920 per year.
The 2018 nominal U.S. median income per capita was $33,706. An American earning $33,706 is responsible for an estimated $4,993 in federal income tax plus FICA tax annually, according to the SmartAsset tax caculator.
By deducting the $5,920 in mortgage interest payments per year, that income drops to $27,786 and the annual estimated tax burden falls to just $3,830. In other words, the Mortgage Interest Deduction would save this American $1,163 per year in federal income tax.
Over the course of 30 years, that annual number adds up to $34,890 in total tax savings throughout the course of the mortgage.
Once interest is factored in on a 30-year $250,000 mortgage, the total cost of the home jumps to $427,601. That $34,890 in tax deductions can bring the total net cost of the mortgage back down below $400,000 to around $392,711.
The Mortage Interest Deduction Caveat
The caveat to the Mortgage Interest Deduction is that taxpayers must itemize their deductions and give up the standard deduction to even be eligible for the mortgage deduction. The standard deduction was $12,000 in 2018.
The hypothetical American above who was allowed to deduct $5,920 in mortgage interest payments per year would need to have at least another $6,080 in itemized deductions to offset the lost $12,000 standard deduction.
In other words, the Mortgage Interest Deduction is typically only a viable option for the wealthiest homeowners.
Brookings Institute economist William Gale has said the Mortgage Interest Deduction is regressive in nature, with the vast majority of the benefits going to the wealthiest 25% of U.S. households.
“Many new U.S. homeowners do not itemize or are in the 15% bracket or lower, so the mortgage interest deduction provides little or no current benefit to them anyway,” Gale wrote.
Homeowners who don’t consider the interest that will accrue on a 30-year mortgage may end up paying significantly more for their homes than they realize they are paying. On the surface, the Mortgage Tax Deduction may seem like a way to mitigate these costs, but the reality is that the deduction isn’t helpful for the majority of new homebuyers.
Most financial experts recommend paying down or avoiding debt as much as possible, but paying cash for a home is not a viable option for many Americans. Regardless, anyone considering taking out the largest loan of their life should first make sure to fully understand the implications and perform a basic cost-benefit analysis on the alternatives.
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