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THE INTEREST TAX-DEDUCTION MYTH

 

One of the most perplexing statements I hear from people is: "I need a mortgage because I need an interest write-off on my taxes – it saves me money." Let’s get one thing straight – Interest is Interest, regardless of the tax benefits. When I hear someone try to justify their interest through a tax deduction, my first thought is, “If tax deductions are what we want, then maybe we should all refinance to a higher rate so we’ll have an even bigger write-off.” It doesn’t make much sense when you put it that way, does it?  

The tax deductibility of interest on mortgages has created a huge myth in our country; it’s an argument that holds very little water. The truth is, paying no interest and not getting a tax deduction is much better than paying interest and getting a tax deduction.

Let’s consider an example. Say you have a mortgage and you pay $7,000 a year in interest. Let’s assume that you are in a 25% tax bracket and that all of the interest is tax-deductible and that it results in a tax savings of $1,750. At the end of the year, you paid $7,000 in interest but were able to avoid $1,750 in tax so the net cost was only $5,250. If, instead, you had no mortgage and just kept that $7,000 in your pocket, you would still have to pay tax on that money, so $1,750 (25% of $7,000) of it would disappear but you would still have $5,250 left over to use however you please. Does it really make sense to say that you want to pay interest just so you can have a tax deduction? Not really, because in the end the interest always costs you something - even after the tax deduction - and that is money you could have kept. 

Remember, the end goal is to pay off the mortgage, not drag it out forever. Tax deductions are nice and we will gladly take them until the home is paid off, but let’s not delay paying off a home in the name of a deduction.


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