Mortgage debt is “good debt” because it saves you money on your taxes – amiright?
That was never 100% accurate – the truth has always been more nuanced – but that argument has gotten a whole lot less true this year.
I just did my taxes this weekend, and got Turbo Taxes lovely warning that I’d hit the SALT (state and local taxes) limit. That limit, coupled with the higher standard deduction, has annihilated mortgage interest as a deductible debt for most of us.
So let’s talk about how deductions worked last year, how they work this year, and why mortgage interest as a deductible type of debt is now dead for all but the very wealthy.
Itemization vs. Standard Deduction – How It Works
First of all, you should know that the “mortgage interest is deductible” argument has always been a bit squishy.
Mortgage interest, like property and state taxes, was only ever deductible if all your deductible expenses added up to more than the standard deduction. Way back in the 2017 tax year, that number was $12,700 for married filing jointly ($6,350 for single and $9,350 for head of household).
The most common itemized deductions include property taxes (car and home), state income taxes, mortgage interest, and charitable contributions. There are other things you could itemize, but those were the big ones.
What did this mean for taxpayers? Well, your mortgage interest deduction was only helpful for the amount of mortgage interest you paid over the standard deduction amount.
Let’s look at an example:
- In 2017, Jane and John paid $2,500 in taxes on their house, $3,000 in state income taxes, $500 in taxes on their cars and $5,000 in mortgage interest. They also contribute $2,000 to charity, making their total deductions $13,000.
- This meant that only $300 of their deductible expenses actually “saved taxes”. For the first $12,700 they paid, they could have taken the standard deduction and been better off financially.
- The higher their mortgage interest is, and the higher their charitable contributions, the more itemizing helps financially.
Lets now look at a higher tax state, so we can look at the impact the changes in SALT deductions and the standard deduction in 2018.
- In 2017, Sue and Abe paid $6,000 in taxes on their house, $9,000 in state income taxes, $1000 in car taxes and $5,000 in mortgage interest. They also contribute $2,000 to charity. This totals $23,000.
- For them, all their mortgage and charity contributions are “deductible”. This is because their state and property taxes alone total $15,000 – $2,300 over the standard deduction amount.
People will sometimes look at those numbers and think people must be earning a high income to pay so much in taxes. Sometimes that’s the case, but other times, you’re paid more to compensate for the fact that you take home less money.
Even back in these days, although about 45 million people itemized, many did not.
The financial equation on mortgage interest is about to look very different now, though, with the limit on state and local taxes (aka SALT) and the increase in the standard deduction.
How The Tax Bill Changed The Game
When the tax bill first was finalized, I could tell it was going to have a pretty big impact on me for a few reasons:
- Limit on SALT taxes. The total of my state and local (property) taxes would be capped at $10k.
- No more personal exemptions. Which led to
- Higher standard deduction.
The standard deduction for Married Filing Jointly this year is $24k.
Even without the SALT cap, that change alone was the death knell for me itemizing. I don’t have $24k in deductions.
Let’s take a look at our example couples above to see how this change impacts them:
- In 2018, Jane and John paid $2,500 in taxes on their house, $3,000 in state income taxes, $500 in taxes on their cars and $5,000 in mortgage interest. They also contribute $2,000 to charity, making their total deductions $13,000. They take the standard deduction this year, getting a $24k deduction.
- The SALT limit change didn’t impact them, because their home + state + property taxes are only $6,000.
- In 2018, Sue and Abe paid $6,000 in taxes on their house, $9,000 in state income taxes, $1000 in car taxes and $5,000 in mortgage interest. They also contribute $2,000 to charity. This totals $23,000.
- The SALT limit change impacts them because they paid $16,000 in state and local taxes but can only itemize $10,000. When you add on their mortgage interest and charitable contribution, you get $17,000 they could itemize.
- They would have to have mortgage interest payments of over $12,000 per year to itemize a single dollar, assuming they still contribute $2,000 to charity.
- Sue and Abe will also take the standard deduction of $24k
This means that I bear the full cost of my interest rate, with no deduction to offset it.
The value of a mortgage has now changed quite a bit.
So How Does This Change The Value Of A Mortgage
People have been talking for years (and years) about eliminating the mortgage interest deduction. This hasn’t eliminated it per se, but it’s made the deduction useful mostly to people who carry large mortgages.
The average 30 year interest rate as of this writing is about 4.5%. In order to pay interest each year of over $12,000 (to stick with our above examples) you would need a balance at or above around $260k. As your balance falls below $260k your annual interest paid will go under $12k and you’re back to the standard deduction.
A $260k mortgage might sound like a lot, or a little, depending upon where you live. With the median US home price sitting around $200k, it’s a lot for your average person.
I live in a high cost of living state (CT) and our median house price is $242k. So even in a higher cost state, only people who are buying “above average” homes will qualify to deduct their mortgages.
To me, this strengthens the case to pay off your mortgage. The old argument that your interest rate should be considered lower because you could deduct it is gone for most people. Why keep the debt hanging around unless you can earn more (risk-free) than your mortgage interest rate?
How Will This Change The Housing Market?
When I posted about this on Twitter I got some interesting thoughts on how this might change the housing market in the future. I’d love to know your thoughts in the comments, but here’s what folks were saying:
It will be
Are you impacted by the SALT limit? How do you think this change will impact the benefits of home-ownership, and of holding a mortgage? Let me know in the comments!
I know my charity contributions aren’t likely to help on my taxes this year, but decided to keep them, because I was donating to support causes I believe in, or support friends doing charity events, not just for a tax write off.
I never really saw the mortgage deduction as that big of a benefit. If a person was able to pay off their mortgage, then they get to (a) keep & invest the mortgage payment money and (b) hold their own money for property taxes, and benefit from interest on it (instead of the mortgage or escrow company).
Someone I know who is very diligent about paying things on time, ended up with a notice of unpaid taxes. Because the mortgage had been sold 3 times in a year, and the corresponding tax info didn’t go with it, they were paying the full amount to the mortgage company(#3), who wasn’t accounting for the taxes. Yikes!
For someone not in a place to pay off their mortgage, yes, the deduction helps/helped, but they should be able to pay the full cost of the mortgage if they are buying the house. Just like if you buy a car, you need to be able to afford to put gas in it, change the oil, and buy new tires when needed. It’s more than just the sticker price of the car.
We paid off our mortgage back towards the end of 2016. I had some reservations about it since the stock market at the time was booming, but ultimately decided that I wouldn’t be able to live with myself if the stock market tanked and I therefore missed the opportunity to be debt free. I also thought there was a high level of risk at the time, since my gut feel was that a certain personality was going to win the election “bigly” and people at the time were saying that the market would drop like a rock if that happened.
So, yeah, that bet didn’t work out so well. Another lesson in market timing 🙂
Overall, I’m happy with the decision to pay off the mortgage. The elimination of the SALT cap make that even easier to justify financially, since (like you) the new standard deduction is much larger than the amount we were paying for mortgage interest plus the SALT cap so I wouldn’t have itemized. Of course, the other benefit of being debt free is that I can watch the market do its thing without worrying too much about it – even with all the swings in the market, it’s still the best option we have for long-term growth.
But there was a big upside to the tax bill, which is that those of us with higher incomes (up to $400K married) are now eligible for the child tax credit! I don’t believe I ever had a chance to use it before now. At $2000 per kid, our taxes this year actually went down substantially. My suspicion is that for most families with a mortgage, the loss of deductions from the SALT cap is probably mostly offset by the higher child tax credit and (slightly) lower tax rates across the board.
“I’m wondering if the new standard deduction is going to make people buy even more house” — that comment you got on twitter really amazes me. I would guess most people would realize they no longer have a mortgage deduction and as the word gets out on that, I believe home ownership will become less popular. Couple that with rising interest rates and I believe we have probably seen the high of the real estate market. This interests me personally more that the topic of paying off the house, as we’ve already done that years ago, even though it was not as “smart”! But since we own 2 rentals outright, I’ve wondered about selling and like to get a read on which way the market might be going.
Thanks so much for a head’s up on the tax situation. Most of us have not yet started on the taxes and with all these changes, it’s really nice to have your example.
I have a small mortgage, so the only time I’ve gotten to itemize was when we had huge medical expenses one year from Tim’s dental implants. So it’s the new deductions don’t really affect me in that sense, but I do think it’s problematic for a lot of people.
That said, I’ve never understood the argument about carrying debt because it’s tax deductible. It’s still debt, and the interest you’re paying more than negates the tax benefit (if you have the option of paying it off).
I expect we will take the standard deduction this year as well, unless a separate investment we have kicks us over (unlikely). Regardless, our home has been a very good financial decision for us, but I’ve never considered the deduction in that analysis.
We’ve never itemized, I always check to see if we would have enough deductions but with modest income and low mortgage balance and a no income tax state (so we have higher sales tax and the system is regressive and benefits the rich over the low income…) we probably won’t see much change this year. I haven’t completed our taxes yet but the only reason we might get any money back is that I ramped up retirement savings significantly halfway through the year.
I hope this is actually a stepping stone in getting rid of the mortgage tax deduction. It is essentially a government cash benefit to people who are the least in need of assistance. We all want to get the best deal but it’s an unfair system that we’ve created by hiding welfare as tax breaks forcing people who most need help to wait in line to apply and prove how poor they are or wait a year to get a tax refund and giving tax breaks to people that don’t need it and lowering their effective tax rate to the same or lower than people who earn half or less.