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| Writing off mortgage interest | |
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| Tweet Topic Started: Oct 9 2011, 10:39 AM (109 Views) | |
| Maker13 | Oct 9 2011, 10:39 AM Post #1 |
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Figured this would be a good place to ask a question. I bought my first house this year and have been trying to figure out some things in this new, scary world of home ownership. I'm looking at investing some money and am trying to figure out expected gains for different options. One idea I'm thinking of is just dumping the money into my mortgage instead. If I sell in, say, 5 years, then I would save $2,500 in interest right there. My question is, though, what would the actual savings be? I don't have a full understanding of how writing off the interest from taxes. I'm seeing rough estimates that only 30% generally gets written off, and haven't found a clear explanation of it. Anyone able to offer a description? |
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| HoosierLars | Oct 9 2011, 05:16 PM Post #2 |
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The amount of interest that gets "written off" and stays in your pocket depends on your marginal Federal tax bracket. Your mortgage interest is subtracted from your income (when you itemize your deductions.) Let's say you have a 5% mortgage, and are in the 20% tax bracket. You can think of the mortgage interest deduction as giving you a discounted interest rate. For this example, your "effective" mortgage rate would be (1-0.2) * 5% = 4%. Now let's say you have 10k that you can either invest or pay down the principal of your mortgage. You decide to invest it at 5%. When filling out your tax return, you claim the 5% as income, and pay the Feds 20% of this, so you really pocket 4% after taxes--the exact same rate as your "effective" mortgage rate. So I think the bottom line is if you can invest that 10K in something that is earning more than your mortgage interest rate, you are going to come out ahead (assuming your investment is safe). Judging return vs risk is one of the key aspects of investing. You will always hear about the guy getting rich from buying penny stocks, but there are probably five5-10 similar investors who lost a lot of money. Clearly, if you use extra money to pay off your mortgage principle, that's about as safe as it gets. One thing to consider is interest rates. If the world economy gets back on track in the next 2-3 years, there's a pretty good chance that inflation could be pretty high, e.g. > 5%. In that environment, you would be better off putting your extra investment income in a money market fund earning >5% interest. If you couldn't "write off" your mortgage interest (which we are assuming is 5% for this example), you would need to earn 5%/0.8 = 6.25% on your alternative investment to come out ahead compared to paying down your mortgage, because the Feds are always going to take 20% of your investment profit. |
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| eelbor | Oct 10 2011, 08:15 AM Post #3 |
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Another thought on this. Your interest payments are itemized deductions from your income. If your pay enough interest and other itemized deductions to exceed the standard deduction(file a 1040 and a schedule A rather than a 1040 EZ) then you get to claim these itemized dedcutions rather than the standard deduction. Your tax benefit is only the amount of itemized deductions over the the standard deduction. The real gain on paying a mortgage early is not in the taxes. If you pay early you deduct less interest. Go look at a mortgage calculator. Assume you have a 30 year note on a $100,000 house you paid 20% down on at 5% interest rate. You start owing $80K in all three cases below. Case 1. You pay the mortgage off as planned. Your House is fully paid off in 2041, and you end up paying a little over $74,000 in interest over the lifetime of the loan. Case 2. At the end of year 1 you pay $5000 extra on your principle. Your house is paid off in 2038, and you end up paying a little over $60,000 in interest over the lifetime of the loan. You also have 5k more equity in the house the moment you make the payment, which is nice when you go to sell it. At the end of the loan you have effectively tripled the value of your $5000 prepayment, but over the course of 26 years. That is less than 5% growth per year on your prepayment. Case 3. Divide an extra payment by twelve and add this result to my monthly payment. This means you are making an extra payment to principle every year. Now instead of the $429 monthly payment in the two cases above you are paying $469 a month. Your house would be paid off in 2036, and you pay about $59k in interest. In addition you now have the original $5k to invest somewhere else. My advice? Take option 3. Invest your money elsewhere, and bite the bullet and increase your monthly payment by 10%. Then you get all the benefits of both investing elsewhere and paying your loan down early. If you run into financial difficulty you can always stop paying extra on your note, and the investment money you did not pay on the house may be available to help you. |
![]() "Liberal, shmiberal. That should be a new word. Shmiberal: one who is assumed liberal, just because he's a professional whiner in the newspaper. If you'll read the subtext for many of those old strips, you'll find the heart of an old-fashioned Libertarian. And I'd be a Libertarian, if they weren't all a bunch of tax-dodging professional whiners." - Berkeley Breathed Meat is Murder. Sweet, delicious murder. | |
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| Maker13 | Oct 10 2011, 09:00 AM Post #4 |
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Lars, thanks for the breakdown. That's exactly what I was looking for. It's definitely helpful in getting the known side figured out. Eel, I appreciate the advice. I haven't worked it out with the bank yet, but my plan had been to make an additional payment each year. I figure should help out quite a bit, knock down the length of the loan to 24 years. I have no idea what's gonna happen 30 years from now to know if I'm going to get the full gain of dumping the money in the principal, so I'm trying to limit my expected gains in interest saved to more realistic lengths (5 years in this example). Unfortunately, this isn't a low-risk deal. It's a new company doing their series A round of capital investment. Tough choices. |
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| eelbor | Oct 10 2011, 09:53 AM Post #5 |
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Zen Master
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If the name of the company is Solyndra, i would put my money on the mortgage. |
![]() "Liberal, shmiberal. That should be a new word. Shmiberal: one who is assumed liberal, just because he's a professional whiner in the newspaper. If you'll read the subtext for many of those old strips, you'll find the heart of an old-fashioned Libertarian. And I'd be a Libertarian, if they weren't all a bunch of tax-dodging professional whiners." - Berkeley Breathed Meat is Murder. Sweet, delicious murder. | |
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| HoosierLars | Oct 10 2011, 10:06 AM Post #6 |
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Eel makes a good point, that the Feds give you the "standard deduction", and you don't see any tax benefit from itemizing your deductions until you exceed that threshold. Using one of the popular tax apps is an easy way to evaluate a few possible tax scenarios. If my favorite guy, Herman Cain, get elected, we will need to see how his 9/9/9 plan affects you! (besides the obvious advantage of cheaper pizza) If you put money in the company and it does great, then you will feel rich. If you lose all of your money, you will feel sad. My personal approach would be some compromise position. Edited by HoosierLars, Oct 10 2011, 10:26 AM.
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| Maker13 | Oct 10 2011, 10:55 AM Post #7 |
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Haha, that's some solid financial advice right there! Can't compromise unfortunately. The series A units are only being sold as very big chunks. I'm only looking at buying one of them. |
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| eelbor | Oct 10 2011, 11:34 AM Post #8 |
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Risk/reward. Home ownership is not risk free either. How much have home values dropped in the past 4 years? If you can not afford to lose the money and still be able to survive, you should not be investing it in the first place. |
![]() "Liberal, shmiberal. That should be a new word. Shmiberal: one who is assumed liberal, just because he's a professional whiner in the newspaper. If you'll read the subtext for many of those old strips, you'll find the heart of an old-fashioned Libertarian. And I'd be a Libertarian, if they weren't all a bunch of tax-dodging professional whiners." - Berkeley Breathed Meat is Murder. Sweet, delicious murder. | |
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| Maker13 | Oct 10 2011, 12:22 PM Post #9 |
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I understand the concept. I have pretty loose requirements on money. My dad was always annoyingly cheap, and that flowed down to me. I hardly ever spend money on stuff and am exceptionally fortunate to be in a situation where my bank account grows each month. I can't describe how lucky I feel to be in the situation I am. The big benefit is that it does let me be a little more risky with money with the big stuff. If it doesn't pan out, I made a bad choice and it sucks to be out the cash, but I don't have any life requirements on the money. Just want to do something with it that's better than a 1% savings account and have this opportunity in front of me. |
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| HoosierLars | Oct 11 2011, 10:11 AM Post #10 |
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You can get 1.13% for a one year CD! Whoo-hoo!! Find Highest CD rates - At a Bank Near You www.google.com/advisor/uscd 1-year CD 1.13% APY ($1000 min. balance) 3-year CD 1.95% APY ($100 min. balance) 5-year CD 2.40% APY ($2500 min. balance) |
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