SLADE COLUMN: For many home buyers, interest deduction's worthless
If you're a potential first-time home buyer, you've probably heard that deducting mortgage interest payments from your federal taxes is a benefit of homeownership. But how much should that tax deduction figure into your calculations about what you can afford?
For most homebuyers in the Lowcountry, the answer is: not much.
The mortgage interest deduction can be valuable for some people, particularly single homeowners and people with expensive homes or second homes, but most homebuyers aren't single or wealthy.
For a married couple earning around $60,000 and buying a house worth three times that much, which is roughly the median home price for the Charleston area, the federal mortgage interest deduction most likely would be worth nothing.
First, mortgage interest is not a tax credit that reduces your tax bill dollar-for-dollar. It's a deduction that can reduce your taxable income, but it can be claimed only if you itemize instead of taking a standard federal tax deduction.
So, you don't save a penny due to mortgage interest payments unless those payments and other itemized deductions exceed the value of the standard deduction you would otherwise claim.
For a married couple filing a joint return, the standard tax deduction for 2012 is $11,900.
At current loan rates, annual mortgage interest on a median-priced Charleston-area home would be about $5,600 in the first year, and less after that because you pay less interest as a mortgage loan balance declines. (In this example I'm assuming a $185,000 house, 10 percent down payment, and a 30-year loan at 3.4 percent interest).
So, with that much mortgage interest, a married couple would need another $6,300 in itemized deductions just to equal the value of their standard deduction. Tax savings would only materialize (and it would only make sense to itemize) if deductions for mortgage interest, state and local taxes, charitable contributions, excessive medical expenses and so on exceeded the value of the standard deduction.
At today's rates, the interest on a 30-year mortgage loan would not equal a married couple's standard deduction unless they borrowed more than $350,000. Tax savings would then come from itemizing additional deductions.
Those calculations illustrate why about two out of three taxpayers take the standard deduction: because it's worth more to them than itemizing.
The mortgage interest deduction is a different story for unmarried homeowners. The standard deduction is $5,950 for singles and $8,700 for heads of household (who are mostly single parents). With lower standard deductions, it's easier for unmarried homeowners to realize tax savings by itemizing mortgage interest and other expenses.
Of course, when mortgage interest rates are high, the mortgage interest deduction is more valuable, because there's more interest to deduct. But this isn't 1982, when interest on the average mortgage loan was above 16 percent. Rates have been falling and falling, and now hover around new lows.
The interest deduction is still quite valuable to higher-income homeowners with large loans on first and second homes. A family paying a top federal rate of 33 percent saves $330 for every $1,000 in deductions, while a family in the 15 percent bracket (taxable income up to $70,700) saves $150.
Potential home buyers, as well as existing homeowners, may be wondering if the federal mortgage interest deduction is going to be eliminated or reduced during budget talks in Washington. It's one of the costliest tax breaks in the U.S. tax code, so it's understandably getting some scrutiny.
Published reports during the past week have said lawmakers on both sides of the aisle in Congress are increasingly open to some sort of limits, such as capping deductions for high earners or reconsidering deductions for interest on second-home loans.
But for those who are new to the concept, here's the bottom line: If you're a middle-income couple shopping for a midpriced home in the Charleston area, the mortgage interest deduction may not save you anything at all, so don't count on it reducing your housing costs or increasing your income tax refund.
Reach David Slade at 937-5552 or Twitter @DSladeNews.