Mortgage Interest Tax Deductions Are Only For Rich People

Want to save money on your taxes? Think owning a house helps you get a large tax refund because of the interest you pay on your mortgage? Paying interest to save on taxes is a bad tax return tip. While some people save a small amount of money with the mortgage interest tax deduction, it mainly benefits the rich. Maybe paying off your mortgage isn't a bad idea? Find out my thoughts!Sadly many people think they’re saving a ton of money on their taxes when they buy a home.

Why? They think they’re going to get a huge tax break with the mortgage interest tax deduction.

Those people are in for a shock when they complete their first tax return after being a homeowner.

The mortgage interest tax deduction may have originally been for the average family, but it has always provided more benefit the rich more.

Why? The mortgage interest tax deduction allows you to deduct the interest paid on a mortgage on your primary and/or second home based on mortgage debt of up to $1,000,000. You can also deduct the interest on up to $100,000 of home equity debt.

The normal American cannot afford anywhere near these limits stated in the mortgage interest tax deduction rules. Even if an average married person can afford a $300,000 home, the tax deduction won’t even help you one bit unless you have other itemized deductions you can claim.

How can this be? The following example may shock you.

A $300,000 Home And No Mortgage Interest Deduction For Some

Let’s say you buy a $300,000 home. You put 20% down, so you’ll have to take out a mortgage for $240,000. Today you could easily get a 30 year fixed rate mortgage with a 4.5% interest rate if you have good credit. In the first full year of paying off your mortgage, you’ll only pay $10,720.29 in interest payments.

Unfortunately, that won’t help many people one bit. Why?

Itemizing Deductions Replaces Your Standard Deduction

When you itemize your deductions, you give up the standard deduction. In 2014, the standard deduction is $12,400 for married couples filing jointly and $6,200 for those filing single. 

If you’re married and have no other itemized deductions, which is admittedly unlikely, you won’t even itemize because the standard deduction would give you a bigger tax benefit. Your mortgage interest tax deduction is essentially useless in this case.

If you’re single and have no other itemized deductions, you’ll actually get to itemize your deductions. However, don’t think for a second you get $10,720.29 in deductions as your benefit. Instead, the only tax deduction benefit you’ll gain is the amount by which your itemized deductions exceed your standard deduction.

So, as a single person, you’d get $4,520.29 in additional deductions due to the mortgage interest deduction. If you’re in the 25% tax bracket, this would save you $1,130 in federal income tax. As a married person, you’d get no benefit at all. Not one penny saved in federal income tax. Sad! [Related: How Tax Rates Work In America]

Keep in mind, you pay the most interest in the first year of your mortgage. Every year after the first year, your mortgage interest tax deduction will shrink because you’re paying less interest each year.

On top of that, the standard deduction generally increases with inflation. That means your benefit will shrink even more as inflation increases the standard deduction.

How The Mortgage Interest Tax Deduction Favors The Rich

Let’s pretend I’m rich and am swimming in money. I’ve decided to take out the maximum mortgage amounts allowable under law to maximize my mortgage interest tax deduction. I have $1,000,000 in mortgage debt at 4.5% and a $100,000 home equity loan, also at 4.5% both on a 30 year amortization schedule for simplicity’s sake.

With this maximum level of mortgage debt, I’d pay $49,136.97 in interest that would qualify for the deduction. I’d assume because I can afford such a large mortgage, I’m probably in a higher tax bracket. I’d likely have a 28% or 33% marginal tax rate depending how much of my income is derived from wages vs investment income.

As a single person, I’d get an additional $42,936.97 in deductions. At the 28% tax bracket I’d save $12,022.35 in federal income tax and at the 33% tax bracket I’d save $14,169.20 in federal income tax.

As a married person, that would result in an additional $36,736.97 in deductions. At the 28% tax bracket I’d save $10,286.35 in federal income tax and at the 33% tax bracket I’d save $12,123.20 in federal income tax.

The rich person who can afford $1,100,000 in mortgages gets to save anywhere from $12,000 to $13,000 more in federal taxes paid than the normal person with a $240,000 mortgage! That’s messed up! Why are we subsidizing homes for the rich? Why not help the normal Americans looking to buy a home more?

Granted, they are paying more in interest to the bank, but why subsidize it?

Normal Americans Used To Benefit From The Deduction

Normal Americans used to be able to benefit more from the mortgage interest deduction. Unfortunately, that’s because they were paying a lot more in interest.

Mortgage rates are currently at one of the lowest points in history. If you had the same size mortgage now vs 20 years ago, you’d be paying less in interest today.

Paying less in interest is a much better deal than getting a bigger tax deduction. Tax deductions only reduce your taxable income, not the tax you pay, you only save a fraction of each dollar you pay in interest on your tax bill. However, let’s run the numbers real quick.

In 1994, mortgage rates were as high as 9% on a 30 year fixed rate mortgage, essentially double today’s rates. On a $240,000 mortgage, you’d pay $21,533.46 in interest in the first year.

For a single person in the 25% tax bracket that would result in a $3,833.37 reduction in their federal income tax due and for a married couple filing jointly, also in the 25% tax bracket, it would result in a $2,283.65 reduction in their federal income tax due.

But The Rich Have Always Had A Larger Benefit

While normal Americans used to benefit more from the mortgage interest tax deduction, the rich have always received a larger benefit. Using the same 9% interest rate, a rich person with $1,100,000 in qualified mortgage debt would see a larger reduction in their tax bill. They would pay $98,695.02 in interest in their first full year of their mortgage.

For a single person in the 28% tax bracket, their federal taxes would be reduced by $25,898.61 and for a single person in the 33% tax bracket, their federal taxes would be reduced by $30,523.36.

A married person in the 28% tax bracket would see their federal taxes reduced by $24,162.61 and in the 33% tax bracket they’d see their taxes reduced by $28,477.36. 

Keep in mind, there are many other calculations that go into tax calculations and the rich do have their itemized deductions phased out at a certain point. Normal Americans will likely have other deductions they can itemize, too. [Related: Be Wary Of Year End Charitable Contribution Phone Calls]

No matter what, the home mortgage interest tax deduction is no longer as useful as it once was for the ordinary American. It has always benefited the rich more.

That said, why is the limit on mortgage debt $1,000,000 or $1,100,000 with home equity debt? Wouldn’t something like a $500,000 still help the average American while not subsidizing housing for the rich? I’d love to hear your thoughts! Let me know what you think in the comments below.

Photo by: LipBomb Text added by: Lance Cothern

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About Lance Cothern

Lance Cothern, a Certified Public Accountant (CPA) licensed in the Commonwealth of Virginia, is the founder of Money Manifesto. You can read more about him here or connect with him on Facebook, Twitter, Google+ or Pinterest.

Comments

  1. Lance, interesting article this morning. You are correct in that mortgage interest tax deductions benefit the wealthy. I would say that most deductions favor the wealthy. But, 2 things that I really dislike are (1) a “you” vs “us” mentality – or 1% vs 99% – and (2) how the “rich” can pay so much more in taxes, but then everyone says how it’s not fair how the rich get more deductions.
    Example:
    Rich guy pays $60,000 in taxes and poor guy pays $10,000. Rich guy receives deductions and ends up only paying $55,000 in taxes while poor guy receives no deductions. Rich guy pays $45,000 more in taxes than poor guy but poor guy is complaining that deductions aren’t fair? It doesn’t make sense.

    • I definitely see where you’re coming from Funancials. I just wanted to show people that while everyone talks about how the home interest mortgage deduction helps them, it really mostly only helps the rich in any significant way. The rich normally do pay more in taxes from a total $ perspective, but their overall tax rates are sometimes lower after all of their deductions. Of course, it all depends on who you compare as some rich people will pay crazy high taxes and some more normal people could pay almost nothing depending on their situations. Do you think the $1.1 million dollar cap is fair though? Do you think it should be higher or lower, or it is just right?

  2. I didn’t see this like rich vs. poor as funancials said. I just think that is something the average American needs to know – paying interest on your mortgage is not going to lower your tax bill.

    I was pretty disappointed the first time my ex-husband and I filed our taxes and got nothing out of claiming the interest we had paid. I also worked in an accountants office who did personal income taxes and witnessed countless others complain that their mortgage interest didn’t help them out.

    I think this is something for any soon to be homeowner to keep in mind. Don’t count on your mortgage interest helping your tax bill!

    • That’s one of the main points I was trying to get across and I’m glad you saw it. It’s so sad when people buy a house thinking they’ll save money on their taxes and it doesn’t help at all.

      • The amount you will or won’t save is predictable (at least for the first year, and you can make assumptions that the tax code won’t change drastically). People should just calculate it, and know for sure whether or not they will save money. I recently bought a house, and you can bet I did the math to find out the true cost of owning.

        PS – if you live in a high tax state, the mortgage interest deduction can push you into a making itemizing worth it, then you’ll be able to take advantage of deducting state taxes as well.

        • Great points SP. Just remember that each year after the first, the amount of interest you pay will decrease. You can easily calculate an amortization table through excel or in an online calculator to see how much you’ll have each year for the full length of the mortgage.

  3. It helps if you have other deductions that help you to exceed the standard deduction. We crossed that line a few years ago. We live in a state where retirement income is not taxed….for the moment anyway. So the loss of state income tax deduction put us below the standard deduction. When we build our new house next year, we have to decide whether to take out a mortgage, or liquidate a couple of investments to pay cash. That will require some analysis.

  4. I don’t know….only a certain type of “rich” person gets the benefit of this deduction. The high wage wealthy are capped by the AMT, making most of the mortgage deduction irrelevant.

  5. While I agree that those who pay more interest get a bigger benefit- the rich as you call them I disagree that average households don’t benefit much. I sure do and I am by no means rich. I am single. My itemized deductions just including state, tax, local ta, and housing tax are $17,000 ($7000 state and local income tax and $10,000 interest on my house). Instead of $6,200 I get to deduct $17,000 which equates to over $3000 in taxes saved. True if I had a million dollar mortgage that would be even higher. However, to someone who is not rich that $3000 is the difference between being able to own a home and not being able to really afford one. Everyone please remember that the rich save more because they pay WAY more in taxes. That doesn’t mean the average homeowner doesn’t also benefit from this deduction.

    • There are certain people that will benefit more than others for sure. The point I was hoping people would realize is you really need to look into it to see if it will help you or not. I pay a similar amount of interest but I’m married and live in Florida where we have no income tax, so I don’t get any benefit from itemizing at all!

  6. I will probably cross the line from being able to use it to not being able to use it in the next two years. I don’t see it as something taken away, I see it as a positive, as I’m then putting more money toward principle and less toward interest. After all, would you rather be able to deduct 25% of $1 or have the full $1 go toward your principle payment. That’s effectively the argument.

  7. Lance @ Healthy Wealthy Income says:

    Awesome, I guess I can mark myself down as officially rich! Our charitable contributions easily push us over the mark with mortgage interest. Semi-rich/upper middle class and super charitable gets you there too. It’s a sweet set up come tax time.

    • Congrats on being rich! I definitely think some normal people can get the tax deduction, but it will be because you are very charitable, have high state income taxes or you have a more expensive house living in a higher cost of living area.

  8. Claiming your interest on Schedule A also allows you to deduct real estate taxes and state taxes, which in this scenario would likely push the homeowner over the standard deduction. Regardless, tax deductions will always benefit the wealthy more because they have the resources to take advantage of them.

    • Some people will be able to get state income taxes and real estate taxes to push them over. Others won’t. It is so dependent on the individual situation so hopefully more people quit assuming they’ll get a benefit and start looking at the calculations before they use it to justify buying a home 🙂

  9. Best article I’ve read in months. Many people are ignorant of this fact. The tax deduction only has a marginal benefit for the few middle class people it helps. It is definitely a benefit for the rich. I’m ultra-conservative but am not a fan of this tax break. I’d trade lower tax rates for less of these type of deductions. This deduction incentivized debt. That’s not usually good imo.

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