The US government has blessed us with the ability to deduct our mortgage interest expense from our income. This thereby enables us to lower our tax liability. The maximum mortgage tax deduction ultimately depends on income, which I'll get into below.
Although you could deduct mortgage interest on up to $1 million in mortgage indebtedness in the past, that's no longer the case. The amount was lowered to $750,000 due to the Tax Cut & Jobs Act passing in 2017 for 2018 and beyond.
While the decrease is unfortunate for property owners with large mortgages, at least we still have something. If you go to Canada, Australia, Asia, and Europe, there is no such mortgage tax deduction benefit. Then again, at least they've got cheap healthcare!
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I personally got a 7/1 ARM jumbo for only 2.125% and minimal fees. It's crazy how low mortgage rates are today.
To understand the maximum mortgage tax deduction, we should first do an overview of the marginal income tax rates in America.
Marginal Income Tax Rates
Given the US has a progressive tax system, the higher your income, the more valuable your mortgage interest income deduction becomes. Homeownership with a mortgage is absolutely the best tax shield for everyday folks out there.
Further, owning rental properties is one of the best ways to generate tax-efficient semi-passive income. Rental properties are a focus of mine in 2022+ as the value of cash flow has gone way up.
Let's take a look at the latest marginal tax rates for singles and married couples.
Single Filing Status For 2022
- 10% on taxable income from $0 to $9,875, plus
- 12% on taxable income from $9,876 to $40,125, plus
- 22% on taxable income from $40,126 to $85,525, plus
- 24% on taxable income from $85,526 to $163,300, plus
- 32% on taxable income from $163,301 to $207,350, plus
- 35% on taxable income from $207,351 to $518,400, plus
- 37% on taxable income over $518,400.
Married Filing Jointly or Qualifying Widow(er) Filing Status For 2022
- 10% on taxable income from $0 to $19,750, plus
- 12% on taxable income from $19,751 to $80,250, plus
- 22% on taxable income from $80,251 to $171,050, plus
- 24% on taxable income from $171,051 to $326,600, plus
- 32% on taxable income from $326,601 to $414,700, plus
- 35% on taxable income from $414,701 to $622,050, plus
- 37% on taxable income over $622,051.
The more you make, the higher the marginal tax rate you have to pay. It's important to know your top marginal tax rate because after you earn over roughly $200,000 as an individual and $400,000 as a couple, your mortgage tax deduction gets reduced thanks to the Alternative Minimum Tax (AMT).
AMT is in effect so that higher-income Americans don't end up getting 100% of all the tax benefits.
Also, be aware that Joe Biden is looking to raise taxes on individuals or households making more than $400,000 a year. Hopefully, Joe Biden will also increase the maximum mortgage tax deduction to $1,000,000. However, we can't be certain for now.
The Maximum Mortgage Tax Deduction Can Help You Save Money
What's important to note is that if you are in the top tax bracket, you get 37 cents back for every one dollar in interest you pay on your mortgage.
If you also pay State income tax, you can see how your marginal tax rate can easily reach 50% on your last dollar of income earned! The beauty of the mortgage interest deduction is that it applies to your marginal income, and therefore your highest marginal tax rate.
Even if you don't have a mortgage large enough to take full advantage of the maximum mortgage tax deduction, that's ok. Utilize as much of the mortgage interest tax deduction that you're eligible for to save money on your taxes.
For those in the 12% Federal tax bracket or below, a mortgage tax deduction isn't very beneficial. You would need to have a massive mortgage at a 12% Federal marginal tax rate to receive any benefits because the standard deduction is $12,000 for singles and $24,000 for married couples.
When you're in the 24% marginal tax bracket, that's when homeownership starts making more sense provided you follow the 30/30 rule for home buying.
Homeownership Is Worth More To Higher Income Earners
Example #1
Say you earned $518,400 in 2020 as an individual tax filer (ie single status). Your income from $207,351 to $518,400 is taxed at a 35% Federal Tax rate.
If you paid $50,000 in mortgage interest for 2020, you get to reduce your taxable income by $50,000 from $518,400 to $468,400. As a result, you are paying $50,000 X 35% = $17,500 less in Federal taxes!
Unfortunately, AMT will likely knock that mortgage interest tax deduction back by ~30% – 50% given your income is so high as an individual. But still, getting a $8,750 – $12,250 tax deduction is pretty good.
Example #2
Say you earned $136,000 in 2020. Roughly $50,000 of your income will be taxed at a 24% federal tax rate.
If you somehow managed to pay $50,000 of mortgage interest for 2020, your taxable income is only $86,000. As a result, you are paying $50,000 X 24% = $12,000 less in Federal taxes.
But again, you would have to take out a massive mortgage to pay $50,000 in mortgage interest a year. For example, a $2 million mortgage at a 2.5% interest rate would get you there. But no lender would lend you $2 million on an income of only $136,000. The largest mortgage you'd probably get if you had stellar credit is $650,000 (5X your income).
A 2.5% mortgage rate on a $650,000 mortgage equals $16,250 in mortgage interest. Therefore, you'd really only be saving at most $16,250 X 24% = $3,900 in income tax.
One can therefore conclude that owning a home with a mortgage is more beneficial for those who have higher incomes. One can also conclude there is an asymmetric benefit for those who have higher incomes.
Income Phaseout
Taxes are complicated. There is an income threshold where once breached, every $100 over minimizes your mortgage interest deduction. That level is roughly $200,000 per individual and $400,000 per couple for 2021.
Here's how the income phaseout works with the previous income threshold for an individual of $166,800.
Just know that if an individual has an adjusted gross income of over $166,800 your mortgage interest starts to get phased out. For every $100 of income over $200,000 you lose $3 of itemized deduction X 33.3% up to a maximum loss of 80 percent of your itemized deductions. Talk about another overly complicated rule the IRS/government has implemented!
Example: You make $266,800 and you have $50,000 in mortgage interest deductions. Take $266,800 – $166,800 = $100,000. Then take $100,000 X 3% = $3,000. Finally, take $3,000 X 33.3% = $999. You can now only deduct $49,001 ($50,000 – $999) from your income instead of originally $50,000.
In my example of the person making $518,000 and paying $50,000 in mortgage interest for the year, the homeowner can only deduct about $45,800 given the phaseout. As a result, the homeowner has to pay $2,000 more in taxes.
Note on The Alternative Minimum Tax
The A.M.T. bars any deduction for interest payments on a home equity loan when loan proceeds are used for purposes other than home improvements. Regardless of your income, you can deduct the mortgage interest.
However, deductions for property taxes and for state and local income taxes and exemptions for the taxpayer and dependents must be added back to arrive at the taxpayer’s alternative minimum taxable income. If the tax to be paid using this method is higher than that from the regular computation, the higher amount must be paid.
Bottom line, you are not going to get the full mortgage interest tax deduction if your individual income exceeds $200,000. So don't be surprised when it comes tax time.
The Best Income To Take Advantage Of The Ideal Mortgage Amount
Given there is an income phaseout and AMT, I say the ideal income a homeowner should shoot to earn is roughly $300,000 per married couple or $250,000 per individual. $250,000-$300,000 is a high enough income to allow for a good life, no matter where you live in America.
With a mortgage interest deduction among other deductions, you can bring your AGI down to $200,000 to $250,000 to fly right under the radar of the government's income threshold to increase taxes.
$300,000 is really the amount of household income I think that is required to live a middle-class lifestyle today in a big city. After taxes, $300,000 is roughly $210,000.
The maximum mortgage amount to get if you want to maximize mortgage interest deductions is $750,000. Therefore, for more expensive homes, you will simply have to put a greater amount down.
Maximum Mortgage Tax Deduction Review
- Homeownership is worth more to higher income earners, but only up to a point.
- Mortgage interest phaseout starts at around $200,000 and has a maximum phaseout of 80% of the mortgage interest.
- The ideal income to earn for homeowners is around $250,000 for singles and $300,000 for couples.
- Earning more than $250,000-$300,000 doesn't do much to improve happiness. It might make you mad due to higher taxes.
- The ideal mortgage amount for the ideal income is therefore $750,000, which equals 3X a household income of $250,000. This also fits perfectly with my 30/30/3 rule for home buying.
- The US government is pro homeownership, therefore take advantage of the benefits.
- You get $250,000 in tax-free profits if you sell your house and are single, double the amount if you are married.
- Single filers get a standard deduction of $12,400 for 2020 ($24,800 for married filers). The government allows you to automatically choose between standardized or itemized, whichever is greater. Given we are talking about $750,000 dollar mortgages as the ideal mortgage amount, itemized deductions will always be chosen.
Note: I am not a real estate lawyer or accountant. But, I do have a multiple property portfolio valued at well over $3 million dollars. In addition, I have spoken with many accountants and real estate lawyers about this subject. I am an active manager of lowering my tax bill and building wealth for the long run.
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The Maximum Mortgage Tax Deduction Benefit Depends On Income is a FS original post. The figures are changing yearly. But overall, the higher your marginal income tax rate and income, the greater the mortgage tax deduction benefit. However, after about a $200,000 individual income, the mortgage tax deduction benefit begins to phase out due to AMT.
hi
can we deduct mortgage interest on purchase of NNN lease properties with 75%% to 80% mortgage loans?
pl. enlighten me
How does the SALT cap impact this analysis? Since this is capped at $10K, when I’m running the numbers, I am struggling to see where this would benefit a married couple. If a married couple buys a $750K house with $600K down at 3.62% interest, they would be paying about $21.5K in interest each year. However, my understanding is you can only deduct $10K of this interest. In either situation, the itemized deduction is less than the $24K standard deduction. What am I missing here? Thank you!
Yes, you would likely just go with the standardized deduction of $24,000 in this case. Depends on your income and intermixed deduction phaseout as well.
The salt deduction is separate from the mortgage interest deduction. If you itemize you can deduct the 10k+21.4k. Also keep in mind this is for federal only. California still allows interest deductions on mortgages up to $1mm
Hi- can you update this post give the proposed new tax changes in the bill being proposed? Sees like mortgage interest write off = $500K threshold now? Also 4 brackets of taxes puts a lot of us into higher 35% rate. My wife and I make a combined 370K and I went for big jumbo mortgage of 650K + 100k line of credit. I will need to make a decision to refi into another 7 yr arm at prevailing rates with no closing costs (original was 3.8%) I have 4 years left on current 7yr until I need to do that. At that point I sell and go for smaller house and mortgage or stay in jumbo to get max tax credits plus bigger house. Your input appreciated
Hi
We are in a 33% tax bracket filing jointly and have a 4 month baby. We rent and do not own any real estate. Please explain, what would be our benefits from a purchase instead of renting.
Thank you very much for your advice
Nick
Check out this post with interesting charts: Buy Real Estate As Young As You Possibly Can
The first example is terrible. The $12500 credit is close to 35% on $33500 taxable income. That’s a great return at any income bracket. However the $17500 deduction is like 3% on a $533,000 income. It’s this kind of math that they will use to change this deduction to a 15% tax credit. High income individuals aren’t getting a good enough return on their taxable income.
Hi Sam,
“$225,000 for singles and $275,000 for couples. With this income level, the largest mortgage I recommend is $900,000.”
So if “$300k income per couple / $1 million mortgage is the sweet spot,” what about a 205K income for a couple? What is he ideal mortgage amount and would you consider that “high income” with your 150k-300K household income example for a 1 million dollar mortgage? How would you calculate the optimal mortgage for somewhere in between 150-300K (e.g., 205K)?
The only way to figure out AMT for your specific situation (will vary based on state income tax (subject to AMT), # of children you have (subject to AMT), your income, your property taxes (subject to AMT) is to plug the #s into a tax software and adjust them around to see where you come out most ahead.
It’s entirely possible that 1 person earning 600k will be subject to AMT because he lives in a state with high income tax (say CA ~10%), has 4 kids (at 4k+ea) and pays 25k in property taxes (all of the listed are subject to AMT). This person WILL BE SUBJECT TO AMT @ 600k income.
Another person, with 1 child, living in a no income state (FL, Tx) paying property taxes of 15k a year will outgrow AMT at that income level and not be subject to AMT.
Hi Sam
Love your blog. Been an inspiration for me (along with the $2M blog).
Havent bought my primary residence yet (my wife and myself are in mid thirties with 2 kids). This year we’ll get kicked into 35% tax bracket. No debt whatsoever. My concern with buying property in NYC suburb area is that I dont think I’ll be staying in my current area, once the kids need to go to school (will need to move to a better school dist. further away). Is it worth buying a house for say 600K, paying 14k in property taxes and then having to move in 5-6 years (and pay real-estate commissions and closing costs). Right now i rent a 5 BDR house for ~3k per month. Given the situation – what would you recommend.
Thanks,
AA.
Thanks for stopping by. Don’t forget to subscribe to my e-mail or RSS feed to keep in touch.
If you know you are going to live in the house for the next 5-6 years and you are in the 35% tax bracket, I would go looking for a house as a primary residence. Owning your home means you are NEUTRAL property. Renting means you are short the property market.
I’m having some property dilemmas myself you might be interested in reading:
https://www.financialsamurai.com/when-is-the-best-time-to-sell-rental-property-three-target-ages-to-consider/
https://www.financialsamurai.com/pay-down-debt-or-leverage-up-to-buy-more-property/
AA,
I would buy the house now rather than later, even if you plan to live 5 or 6 years only. I dont know what the mortgage is like for 600k home but. It maybe anywhere from 4500.to 6k a month…. the same home would pay more in rent let say 5k a month, whihch is 60k a year in 5 years it would be 300k in rent… which is a lot of money to throw out. But lets say that the same house increase 3% a year that means an increase of almost 20k a year, as of now it probably increase a lot more than 3%, if that hold true and you sell the house is like Living there for half the rent or even less than what you would have spend while renting. So, buy if you can, btw lets say all the breaks that you had on taxes goes to comissions and closing of the house.
Here’s my version of what you just said:
The Best Time To Buy Property Is When You Can Afford It
I totally disagree…it’s never better to pay interest on a mortgage than to own a home outright if you can swing it.
In AMT is the income phase out the same (max loss of 80%). Say income is 500K, currently have 300K mortgage at 3% (something like 15k per year mortgage interest. What if a second mortgage for 400K was added to picture?
Are mortgages / mortgage interest on investment properties treated differently?
Thanks Sam– great site!
Tough question. Investment property mortgages are deductions specifically based on the income of your investment property. It’s only the 2nd home mortgage or vacation property where you don’t rent out for more than 14 days I believe which can combine to come under $1 million bucks.
AMT is tricky. If you make more than $150,000 AGI, you start losing the benefits and get hit left and right with AMT.
Thanks Sam. How about fix-up / repair expenses on the investment property– can I deduct those against my W2 income or only to zero out my rental income? I have 4 kids, 500k W2 income, and a modest but good rate mortgage. I get killed by AMT b/c I lose all personal exemptions and due to mortgage deduction phase out. I’m simply trying to figure out if real estate may offer a way to help. I have about 300k cash on hand so I could pay off my current mortgage entirely vs use that liquidity to buy a second home. It is currently doing 0.00001% in cash.
On another of your articles I saw this quote “I fully believe the next 10 years will bring the biggest transfer of wealth ever from savers to levered investors.”
As a saver this certainly rings true, so I am trying to figure out if I should do a 180 degree course correction–
Mahalo!
Great website and great article too. I guess with the new changes for 2013 the numbers will need to be updated. I wonder what the numbers will also be with the new limit on itemized deductions. Thanks again.
Save 17,500 dollars by paying 50k! Great deal! NOT
Good think a million bucks only costs $26,000 a year now.
Much better than paying $26,000 on rent and getting 0 back and zero equity forever.
Hi! I would be interested to know what your thoughts were on a first time home buyer purchasing an income property vs a live in property. I am currently renting in Los Angeles and I am debating whether to invest in a rental property, live in property, or commercial property.
I am 29, have about $500K between my investment account, savings account, and 401K. I want to make some smart strategic moves to ensure my retirement and I am receiving a lot of conflicting advise of what my next move should be. I am thinking real estate just because of the cash flow. I am currently in the 28% tax bracket earning $75K/yr with variable performance bonuses from $65K – $85K/yr. I have paid off all my student loans, have awesome credit and virtually no debt (very low car loan). I am leaning towards commercial property but that would not leave me a lot of room for diversification. I would love your thoughts/advise!!
Actually 46% of homeowners receive no deduction at all because their itemized deductions do not exceed the standard deduction. Most of the $200 billion subsidy to homeowners goes to those at the top. Compare that to the HUD budget of $50 million and it makes you wonder.
Good to hear the majority of homeowners (54%) therefore do get to benefit from beyond the standardize deduction.
For folks in the borderline 25% tax bracket or lower, homeownership as I mentioned in the very beginning is not as beneficial from a tax perspective.
$300k income per couple / $1 million mortgage. That is the sweet spot.
Huh, I never thought of as a reason to buy a home, but I guess that tells you which tax bracket I’m currently not in. That’s okay, though. It adds a new dimension to the rent vs. buy conversation that’s been going around and around and around.
Definitely don’t buy if you don’t have a good cushion after a 20% minimum downpayment. It’s easier to rent.
@ER
I guess I should be giving a little background first. I’m 29. Will be 30 by the time I’m done with residency and start working next fall. I have zero student or car loan and have about 20k in the bank saved up during residency.
I did not know that interest from income properties can be used as expenses! I want to stay in Texas but want to have the freedom to live somewhere else one day (SF sounds pretty wonderful). The amount of income really depends on the amount of days I want/can to work. I can double what I mentioned earlier if I work 26 out of 30 days… but that probably won’t be very healthy. My background in finances/economics is extremely basic. Up until the last several weeks, I didn’t even know what a CD really was. I’ve been making calculations recently and I think i would generate much more income if for example I buy 10 condo with 20k down (20%), than buying 2 outright at 200k. OF course, there are several other factors and my calculations tried to be as conservative as possible. I am really not sure if retiring in 10 years will be feasible, but will definitely try my best.
Jon, by the way, I live in Dallas and will most likely work somewhere in one of the big cities. How about you? are you mainly into buying homes or condos? Which one do you recommend? How about you Sam?
Ah, so I guessed right about the occupation! Nice work.
Don’t come to San Francisco or Honolulu. Once you do, you will never want to go back to Dallas again!
I have several properties, two of which are rentals that bring me good cash flow.
Read: “Achieving Financial Freedom One Income Slice At A Time” to learn more.
Good you are thinking about how to invest your upcoming big bucks! Just spend less than you earn OK?
As you know from the guest post I wrote for you, I’ve always questioned the dream of homeownership. I’ve always questioned it but I’ve never seen the benefit broken down by income level. Broken down beautifully.
Hope you are seeing the light Abe! I’ve been a renter before and a homeowner, and getting the deduction and living in a place of my own truly is a wonderful benefit. Inflation hedge, a potential lucrative investment, and a home!
It’s really about equality e.g. everybody who is a homeowner gets the similar progressive deduction. Sounds logical to me.
It’s the really wealthy who don’t need the deduction, as you can only deduct $1 million of mortgage indebtedness. The really wealthy that I know have no mortgages and pay cash.
The sweet spot is the W2 earner making $250,000-$400,000 imo.
Good post, but looking at it from the other end. For people like me who are making under 100k, when you are calculating your mortgage interest deduction, you have to subtract the standard deduction. I only pay about 12,000 in interest/ prop. tax every year. So I can’t really deduct that amount when I’m doing calculations(obviously I can on my taxes). I really am only getting 12000-5700(std deduction) = $6,300 in deductions.
I have a post coming out soon on this :)
You sure about this regarding the need to subtract your standard deduction from your overall deduction? I always thought it’s choosing whichever provides more deduction? I haven’t made under 100K in a while, so perhaps this is strictly an income issue yeah? Love to read more.
Sorry first comment wasn’t very clear. If I have no house my deduction is $5700(standard). If I buy a house and my mortgage interest/prop tax is 12000 per year. My deduction is 12,000. So by buying a house I am only getting an additional $6300 in deductions. Like I said, makes less of a difference as you make more and mortgage goes up
OK, that makes sense and is clear.
Makes less of a difference UP TO A POINT, which is the point of this article.
Shoot for $300K household income, and feel comfortable with a $1 mil mortgage provided you have the liquidity as backup and consistent cashflow.
yourPFpro.com/calculate-your-mortgage-interest-deduction-the-right-way/
I hope your note is out soon. These figures are hard to follow….
I’ve been a silent reader for many months and I greatly appreciate your post. I will soon be coming into a very decent amount of money per year, approximately 300-450,000 before taxes. I would like to retire (or not having to work if I choose not to) in 10 years. I’ve thought about buying up alot of rental properties per year. Do you suggest buying them in cash or putting 20% down and mortgage instead. If I did that, would the benefit in tax interest deduction be worth it? The properties I am looking at are in Texas near Universities and are generally about 90k-130k for each condo. No where near SF prices. I apologize ahead of time for these loaded questions. Again, thanks Sam for your helpful posts… you are quite a motivator!
Sounds like you are going to be a doctor?
If you are in TX making that kind of money, then just pay cash for your 130K condo, especially if that’s where you plan to live. No state taxes.
You cannot deduct mortgage interest on rental properties for income taxes. They are treated as an expense and directly offset your rental income. This is much better than just an interest deduction as you’re getting 100% back for every dollar you spend on interest as opposed to 35% depending on your tax bracket.
The question of buying in cash or using a mortgage depends on the rate of return you wish to achieve. The more houses you buy in cash, typically the lesser your rate of return. The advantages are you don’t have to deal with financing which has gotten to be an extremely time consuming process over the recent years and also less homes to deal with. For me, I am in a capital accumulation phase of my life so I have all my properties financed trying to maximize my rate of return. Each home brings its own headaches….finding tenants, insurance, protesting property taxes every year for each house, etc but you’ll have many more sources of rental income. BTW which part of Texas are you in as I am also in TX.
I agree about the direct expense deduction to rental income. A beautiful thing.
If I am making $350k a year, I am NOT bothering with getting a mortgage for $80K-$110K. I’m paying cash and leading a simple life if I enjoy living in Texas.
Unfortunately, I like the ocean and mountains and temperature climate here in SF, hence have to pay up.
Owning multiple rental properties is not worth it unless you are completely hands off and own a lot imo.
I agree for the most part, but it totally depends on your stage of life, your current net worth, current income, and goals, and probably 25 other factors hah.
I agree if you already have a million or two and are making 350k a year, probably don’t want to bother. However, a person in early 20’s with only 100k cash with a goal of reaching FI early may want to buy 5 homes with 100k instead of just 1. In my experience, you can have a good property management company take care of everything and you will still have solid cash flow and a significantly higher rate of return than using all cash. This strategy maximizes your return and minimizes the stress of rental homes. The key is finding distressed homes at discount prices, and managing to obtain clever financing arrangements.
Nah, that doesn’t make sense.
To add on to your argument about the income level…since $250K now equals millionaire there will also be the healthcare tax on investment income lol
$250K really is the new $1 million, whoo hoo!
I LOVE the mortage interest deduction, hate the phaseouts. Thanks for the analysis on this. For me, I would rather pay my house off and put my money elsewhere, but if taxes are killing you and you can’t afford to buy a house with cash, using your mortgage as tax leverage is a good idea. We’ve saved a TON in taxes over the last two years, and even got the $8,000 tax credit when we bought. So our home has netted us some money, but we have paid more in interest than we have gained in tax benefit.
Are you getting a better return on your investments than interest you are paying on your mortgage, Sam? If you have enough cash to pay off your house, but your rates are low, then investing that money will get you ahead, no doubt.
Investing isn’t a sure thing, which is why I’ve got 30-35% of my net worth in stocks, 30-35% in CDs, and 30-35% in real estate. I’m too dumb to always outperform the market, but outperforming the 1.5% 10-year yield is not hard anymore!
Sam, you have some nice diversification, but I gotta tell you, that instead of holding those CD’s you can put that money into a good corporate or municipal bond fund, or even a basket of great dividend stocks that raise their dividends…really Sam over the long-term quality stocks easily can appreciate better than 5% per year (even when you include 08/09)…just my opinion my friend..
Joe
I have 30-35% of my net worth in stocks. I’m happy with that. As my 4% CDs roll off, which I’m very happy with as well, I will invest in other instruments.
From my experience, everybody thinks they are Warren Buffet at some point in their lives, only to realize at another point, they are not. How has your personal 10 year stock compounded return been?
The thrust of your argument is focused on taxes, but how about the 55% that is left? Would I rather earn $1 million and have my interest deduction reduced or earn tremendously less and receive 100% of on my deduction? For me, I choose $1 million! If I am earning that much, I will find a solution or pay a high priced CPA/tax attorney to find a solution. Chances are that I would pay cash for that expensive house that the $1 million a year would probably allow me to do. My fantasy is to either have Romney income or be in the highest tax bracket. I think it would be fun to find a way to beat the man. I did it in the days when I owned income property, although it different now.
Being in the highest tax bracket as a W2 earner DOES NOT beat the man. You get screwed by the government.
It’s much easier to earn $300,000 than $1 million.
We’ll likely be only to claim this for another year or two before the standard deduction becomes a better benefit. We might have one instance where we can stagger our property tax payments to have them fall in a year, but even that’s probably a one time thing. The upside is that the low interest rates mean we get to put that to principle instead.
Wow, seriously? I would not be comfortable with my housing cost being 30% of my gross income. Right now, it’s under 20% of my gross base salary and that’s about the most I’m comfortable with.
I tried to keep my housing choices separate from my income and looked more at the costs that would never go away (property taxes, HOA dues). If you buy a $600,000 condo, your HOA dues are most likely to be higher than a $300,000 condo. Same with your property taxes. I also want to make sure that my lifestyle is sustainable even without a job.
I’m with Holly – the ideal income is as much as possible and the ideal mortgage amount is zero.
At the interest rate on my mortgage and the amount of it, I’m not going to be saving much in the way of income taxes – somewhere around $1,000/year. I’d rather just pay off the mortgage. On the other hand, my monthly carrying cost is less than what I would be paying to rent a comparable place and I plan to stay here for at least 5 years, so I think that buying was a good move.
Yes, seriously. This article is more applicable to higher income earners. If you are in the 25% or under tax bracket, it’s not a slam dunk to own.
But, let’s say you make $300,000, a $1 million mortgage interest costs $27,000 a year now with today’s rates. Are you saying spending 9% of one’s gross income is a lot? Hardly. This is the ideal combo.
What would you trade or keep – cheap healthcare or tax deductible mortgages?
The election will indicate this a bit I think. Even though I don’t follow US politics closely, I think Obama will prevail.
Good question. For now, I would MUCH rather have tax deductible mortgages b/c of my income and mortgage amount. Once the mortgage is done, and I plan to get my income comfortably below the “attack” level by the government, then I’ll go for cheap healthcare.
Good call on that.
I’m with you on that one.
The 3% income phaseout does not take effect until 2013, at which time highest marginal rate is set to jump to 39.6%. Of course this all depends on the election results. Moral of the story, always crunch the numbers.
Although I strongly believe Obama will get re-elected, I highly doubt the top tax bracket will rise to 39.6%. Congress won’t let it happen.
It did
Hi Sam,
That is some great analysis.
One question- how does AMT effect the mortgage deduction?
-Mike
Here you go:
Note on The Alternative Minimum Tax: The A.M.T. bars any deduction for interest payments on a home equity loan when loan proceeds are used for purposes other than home improvements. Regardless of your income, you can deduct the mortgage interest. However, deductions for property taxes and for state and local income taxes and exemptions for the taxpayer and dependents must be added back to arrive at the taxpayer’s alternative minimum taxable income. If the tax to be paid using this method is higher than that from the regular computation, the higher amount must be paid.
AMT affects almost all homeowners with mortgages and adjusted incomes over $100,000 nowadays.
Thanks- normally AMT is limiting the deductions so this makes sense. I guess if the property taxes are high this will make for a worse effect.
Yep. It’s complicated, but everything is graduated. After about $300,000 a year in income, your deductions really start disappearing fast!
You miss some additional breaks that are possible to get for low income homeowners. For example, the Mortgage Credit Certificate (MCC) program. The benefits differ by state. Here in NYS, I was lucky enough to get one before they did away with them last year and when I still qualified for income purposes. As a result, I get to deduct dollar-for-dollar the first 20% of my mortgage interest for the life of the mortgage, and then the remaining 80% qualifies for the regular mortgage interest deduction. This is some very real savings on a $400K mortgage (saves 0.95% off my rate annually in my case)! However, with how much rates have come down, it is only finally starting to make sense to refinance (as I will lose the credit on refinancing) and I’m looking to shorten to 15yr fixed or 5/1 ARM.
For a $400,000 mortgage, what is considered “low income” to be able to afford it?
$100,000?
I actually recall the state upper limit to be more like 70K, which I was just under at the time I took out the mortgage in 2010 (based on my 2009 tax return), but had just switched jobs during the spring and the bank qualified me for my mortgage based on my offer letter (and new pay stubs as they came in). So a few months earlier and I would have never gotten the mortgage; a few months later and I would have not qualified for the MCC. Somehow I hit the sweet spot and just barely got the $8K first time homebuyers credit too.
That’s pretty cool the government is encouraging folks to spend 5.8 times their gross income on a mortgage!
If this is really the case, then it truly does pay to be a homeowner, b/c the government will always bail us out if we get in trouble! 5.8X, WOW!
Hahaha, yep, 2005-7 all over again, why do you think we got into this mess in the first place? I’ve been working hard to improve that ratio from 5.8 (2009) to 4.2 to 3.7 to 3.0 (2012 expected), not including non-cash bonuses or a passive stream that is starting to come in this year, but I expect my case is a bit different than average.
Max – how are you doing financially now?
It’s uncanny to see your response, and a relief also. I’ve been scouring this site reading anything and everything. And your situation is almost similar to mines. I just bought an “affordable” condo and am financially JUST IN the sweet spot to have qualified to have purchased it, and also to have received the MCC credit. I also got a low downpayment loan, and the seller paid for most of the buyers fees. I’m not at 5.8x levels, but around 4.5x. I work side gigs for play money, although some if it I’m saving to buy another used car in a few years when my current one breaks down. let me know how your story is going.
What is a downpayment loan and where do you plan to buy?
Leveraging up to buy in an expensive coastal city market is NOT advised after such a huge run up.
See: Buy Utility, Rent Luxury: The Real Estate Investing Rule To Follow
That was a very good post! I have never put much thought into how much the mortgage interest tax deduction allows for various income levels.
But to answer your question….I think that the perfect mortgage amount is “zero” and I think the perfect income level is “as much as possible.” I don’t want to be a mortgage slave. I want to retire as soon as possible!!!!! =)
Too idealistic Holly! IF you have as much income as possible, you are going to be paying out the WAZOOOOOO in taxes! When the city takes 1 month to fix the electricity pole, you’ll get pissed!
$300,000K/$1 million is the perfect balance.
I think Holly has a point.
In your example of the $50,000 you paid in interest, you are still out that $50,000. It’s just profit for the bank. If you did not pay that $50,000 you would have been able to keep $32,500 ($17500 would go to taxes at 35%)
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So you are spending $50,000 to make $17500 back on your taxes?
It doesn’t make sense to me, unless I am missing something?
You missed minusing out the savings for not having to rent.
Really what it comes down to is access to low interest tax advantaged capital. For example, I have a 15 year at 2.875% and pay approximately $20,000 per year in interest of which I net $7,866 (including state) in tax reductions. In effect, I’m getting $700,000 loan at 1.73% accounting for the tax advantages (obviously this slides as the amount of annual interest drops each year). Even though I could pay the mortgage down quickly – there’s really no incentive to do it since I can make 10-12% a year by investing the additional money I might have applied to additional mortgage payments into an ETF in yet another tax advantaged account like a solo 401k further reducing my tax bill. (of course at some time when I retire i’ll have to pay taxes on the gains but hopefully that will be at 15% cap gains instead of 39% on earned income). In fact, I could make the argument that if current mortgage rates continue to be low it would make the most financial sense to have the least amount of equity in your home and remortgage every 5-7 years. Yes you are paying interest to the bank – but where else are you going to access to significant capital (albeit secured) at 1.73%?
Good analysis. I would add that (to the best of my memory) you can also deduct interest generated from up to a 100,000 HELOC loan. All of these rules are subject to change if Congress actually overhauls the tax code though.
Yep, the $100,000 HELOC is in there if for home improving purposes. But, the income limit phaseout will get you over $1 mil.
You’re right about Canadians not being able to deduct the interest from our mortgages. I often wonder how much more debt people here would be in if we were allowed to deduct the interest.
Yeah, and that’s what makes our housing bubble even more laughable. There were huge tax incentives to pile into American real estate. The US even has 30-year mortgage rates! In Canada, you can’t deduct your mortgage interest (save for the Smith Maneuver) AND the longest rate you can get is 10-years (but it’s egregiously high). Our bubble is wavering now. Soon we’ll learn we’re not actually better than America.
Good luck on the Canadian housing bubble folks! Just make sure you can afford to pay the payments in case something happens.
If we all could pay the payments in the US, we’d still be partying!