Your Mortgage Deduction - How you really Lose

Monday, April 24, 2006
I touched on this in my tax rant so let me clarify something a little bit because people don't always really understand this point.

The middle class loves the mortgage deduction. They think its a great deal because they end up saving so much on their taxes.

I'm not here to debate that an individual doesn't on the surface save on their taxes because of the mortgage deduction but people don't realize that their mortgage deduction may actually cost them more than they save in the big picture. A recent study released shows that the top 2.2% of tax returns claim 22% of the benefits.

Think about it. The richest people benefit the most. They have larger mortgages thus more to deduct. They are in a higher tax bracket therefore save more with each deduction. The problem is compounded further because most middle-class Americans DO NOT receive the full value of the deduction!

Let me say that again because most people don't get it. Most middle-class Americans DO NOT receive the full value of the deduction! To achieve full value of the deduction, you must have OTHER deductions totaling more than the standard deduction. The standard deduction for 2005 is $5000. $10000 for married couples. Do you know many people who have $5,000 of itemized deductions? Believe me, most do not. So until you breach the $5,000 mark, your deductions are meaningless; you are better off taking the standard deduction. Even if your mortgage interest (Only mortgage interest is deductible. You wouldn't believe how many people believe the entire payment is deductible) is say $10,000 this year, you don't just lop off $10,000 from your taxable income, you may be able to deduct only $8,000 of that. If you are in the 25% tax bracket you just saved $2,050. Not a small sum but not huge either considering $10,000 in mortgage interest.

Now think about the rich. They easily have $5,000 in deductions from other sources. State taxes alone probably account for this sum. Add on investment expenses, charitable contributions, and business expenses and most of the rich have no problem breaking the standard deduction barrier BEFORE their mortgage interest deduction. They have a bigger house, and larger mortgage, so let's say they spend $50,000 in mortgage interest. They get to deduct this amount fully from their income and at a higher rate, 35%. They save $17,500 from this deduction. Compared with $2,500 for the middle-class person with the smaller mortgage. They benefit 7x more from the deduction and they don't even "need" it!

All the money they don't pay has to come from somewhere. Every dollar they are able to avoid comes from someone else's pocket. That pocket is yours.

This is why I don't like government. People are so worried about their own individual problem that they don't see the bigger problem. If the government were to repeal the mortgage interest deduction (which I would love to see but don't think they should because of the inherent unfairness) those protesting the loudest would be those who are most hurt by the deduction itself. They make you think you are getting a great deal when in the end, you are the one carrying the largest burden.


David Cho said...

That is why the best combination is owning a home and business, which puts you well above the $5,000 even if the business is not big.

Anonymous said...

Hold on there: if your deductions (mortgage interest included) total less than $5,000 and you get to deduct $5,000, you are not losing anything. You get your total deductions plus some EXTRA - granted free to you by the government. This is a $5,000 deduction allowance that BENEFITS lower income taxpayers who get this deduction despite the fact they can't afford higher mortgages and other deductibles. True, they get this even if they don't have a mortgage, so there is no tax benefit to offset their interest, but it is certainly not a tax cost and it is not a rip-off of the poor.

T said...


You say yourself that they would get the $5,000 deduction anyway. They are most certainly better off taking the standard deduction, which I will agree is a good thing.

But look at it from the perspective of an unsophisticated home shopper. So many people talk about how great it is to get the mortgage deduction when in fact, most people don't get it. Many people factor in the deduction they will get when they are buying a home failing to realize that they won't get the full benefit of the deduction.

Further, it most certainly is a tax cost. All other things being equal (yes I know they aren't but economist love to do this anyway) and taking government expenditures as a given, then any sort of tax break for one segment of society is a cost to some other part of society. It is indirect but real.

Anonymous said...

The way I see it the $5,000 standard deduction is a tax break to those who use it and the cost is on the rest of us (not that I'm complaining about that).
Yes, those whose mortgage interest will not push them above the $5,000 threshold should be told that their interest cost is 100% out of pocket, but should not be told that they are having something taken away when they are being GIVEN the $5,000 deduction. I disagree with your premise, "How you really lose" - nothing is being lost.

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