How do you figure mortgage interest

[lillyb]

How do you figure your effective mortgage interest rate after the tax deduction?? For some reason I can't wrap my brain around it this morning, must need more coffee.

To make numbers easy, assuming a 100k loan at 6% and we're in the 25% tax bracket.

$100k @ 6% is around $6,000 paid in interest that year. If you itemize you won't have to pay taxes on this $6k, correct, since the interest is tax deductible? 25% of $6k is $1,500, so you saved that by not paying that amount in taxes that year. Correct so far?? So if you paid in $6k in interest but saved $1500 with the deduction you really only paid $4500, which is 4.5% when it all comes out in the wash, sorta.

Are those numbers right?

I'm trying really hard to weigh the pros and cons of prepaying vs. investing. Interesting discussion going on over there, by the way. Really need the right numbers, so any help??

[lgslgs]

Keep in mind that your standard deduction is something like $10,300 (for married filing jointly).

If your mortgage interest payments are $6000, you will need more things to itemize before it is worth it. State and local taxes and realestate taxes, or medical expenses exceeding something like 7% of adjusted gross income would count.

I always considered the mortgage interest tax benefit to be pretty much zero for us. That's because our mortgage wasn't huge to begin with, so even in our biggest itemizing years our itemized deductions were only a few hundred more than the standard deduction. 28% of $300 wasn't a big enough tax benefit for us to count that as a bonus for keeping the mortgage.

Now that we retired early and have very little taxable income, the standard deduction is quite a bit more than what we could itemize - so mortgage interest benefit is totally nil.



Two thing that persuaded us to keep the mortgage. First - Our net investment return average for the past 15 years that we've been tracking them have been significantly greater than our puny 6% mortgage interest rate.

The other thing that was very important for us was to use a spreadsheet to track cash flow - how much money we could expect to have sitting in bank accounts every month from now until we are age 100.

For us, it was always better to keep the money where could get to it somehow if needed than to tie it up in a house. Especially since we were setting up so that we could quit work early. Home equity in a house that you aren't going to sell, and not having a job so you aren't ever going to go get a home equity loan means that early mortgage payments turns into banked money that we CANNOT ever really access.


With the money in investment accounts we can always get to it if we need to. The value of that money is the nest egg + interest earned - any investment expense. The cost of the money is mortgage interest + any other mortgage costs if we had them (and we don't).



Our big goal with all of this was to have our money (real cash money - not the value of some house we're never selling) earn more than our actual living expenses. We wanted to be able to sit at home, live decent lives, and still have our money in the bank increase every month.

There's just no way in the world we could have done that by paying off the mortgage early.

The only ways that paying off the mortgage early is better is if you have a mortgage interest rate that's higher than your investment earnings (like if you have a pricey loan and you only invest in CDs), or if you don't really, truly bank AND invest the money that you'd otherwise put on the mortgage. You've got to write the investment check just like it was a mortgage check, send it off and get it changed into investments with real earning potential, and never look at that nest egg as a source of money for a vacation, a car, or for any other purchase.




I am so in favor of NOT paying off a mortgage - but it's a risky thing for people who are impulse spenders (even occasional ones) or who are still managing their money in a way where they get "surprise" bills (like annual car insurance and other things that should be expected.) You've really got to be serious about saving the money for the long term to make this kind of thing work - and the only way I know to do that well is to make yourself a good spreadsheet that plans out your lifetime so you can see the financial pros and cons of each possible choice.


That spreadsheet will show you other important stuff as well, like which has the most impact - cutting spending a little every week, getting one more percentage point on your investments, choosing to wait a year to buy the next car, what if you have a kid and your expenses increase.

If you have a super spreadsheet like that, it gets really easy to make decisions like whether you send in extra mortgage payments or whether you keep you emergency fund in your savings account or in mutual funds, or if you really want the slightly fancier new carpet.




Good luck getting it figured. It is well worth the work to do what you are doing with the calculations.


Lynda

[lillyb]

Thank you Lynda, that is the very information I was needing.

You're right, I would rarely ever get over the standard deductions, anyways, so I shouldn't look at it like that.

It's just sort of new to me, I've had the 'pay off your house' mantra in my head for so long that I didn't question it. But now, thanks to the smart peep's on here, it's got me wondering if it's financially smart or not.

Need to go learn some more.

Thanks again!

[lgslgs]

Hi Lilly -

I can't even tell you how many times I've gone back and double checked that I was doing the right thing. Every time someone else posts about how good it is to pay off the mortgage early I go do the numbers again - and I my case it would just be the biggest financial mistake of my life to pay this mortgage off early.

So of course today I get a nice letter from my lender talking about how good it feels to sign up for an early pay off program. Ugh!

Where we're at right now, we ~could~ pay off the mortgage any time we wanted to. And then I could go back to work for a few more years to make up for the financial hit our savings would take.

I'd rather have my house & mortgage working for me while I sit at home, than have it the other way around.

Lynda

[jIM_Ohio]

Originally Posted by lillyb

How do you figure your effective mortgage interest rate after the tax deduction?? For some reason I can't wrap my brain around it this morning, must need more coffee.

To make numbers easy, assuming a 100k loan at 6% and we're in the 25% tax bracket.

$100k @ 6% is around $6,000 paid in interest that year. If you itemize you won't have to pay taxes on this $6k, correct, since the interest is tax deductible? 25% of $6k is $1,500, so you saved that by not paying that amount in taxes that year. Correct so far?? So if you paid in $6k in interest but saved $1500 with the deduction you really only paid $4500, which is 4.5% when it all comes out in the wash, sorta.

Are those numbers right?

I'm trying really hard to weigh the pros and cons of prepaying vs. investing. Interesting discussion going on over there, by the way. Really need the right numbers, so any help??

effective interest rate =normal interest rate* (1-tax bracket rate)

so in my case, 5.75% mortgage, 25% tax bracket.

5.75%*(1-.25)= 5.75%*.75=4.3125%.

The higher your tax bracket, the more significant the deduction.

Your calculation was for the 25% tax bracket, so it did work out similar to my example.

As far as investing, finding an investment which can get 4.3125% in my case is quite easy. 4.5% in your case should also be easy.

[cptacek]

Originally Posted by lillyb

How do you figure your effective mortgage interest rate after the tax deduction?? For some reason I can't wrap my brain around it this morning, must need more coffee.

To make numbers easy, assuming a 100k loan at 6% and we're in the 25% tax bracket.

$100k @ 6% is around $6,000 paid in interest that year. If you itemize you won't have to pay taxes on this $6k, correct, since the interest is tax deductible? 25% of $6k is $1,500, so you saved that by not paying that amount in taxes that year. Correct so far?? So if you paid in $6k in interest but saved $1500 with the deduction you really only paid $4500, which is 4.5% when it all comes out in the wash, sorta.

Are those numbers right?

I'm trying really hard to weigh the pros and cons of prepaying vs. investing. Interesting discussion going on over there, by the way. Really need the right numbers, so any help??

The numbers are right, by the way. You figured it out correctly.

But lgslgs is right, also, that that $6000 needs to be greater than the standard deduction you get.