Having a mortgage solely so you can deduct the interest is (usually) crazy.
I agree. But "usually" is not the same as "always."
You have another $4,000 in deductions (health care, donations, whatever).
Let's take someone a little better off, but still not uber-rich by any stretch. A couple making $200,000 a year. That's not uncommon for two professionals. Let's call them Mike and Ann.
They live in a relatively low tax state and pay 4% in state taxes. That's $8000 in federal deductions. They give a little bit to nonprofits, not a lot but maybe $4000 a year. They also pay property taxes. Those can be deducted IF they own. That's another $2000 a year on that $250,000 house they live in, on average, roughly. They are healthy and have insurance through their employer so they don't deduct any medical expenses. They have about $12,000 in deductions before considering mortgage interest or the property tax deduction. Thus, they can take full advantage of the mortgage interest and property tax deductions.
Now, I'm going to assume you're in the 25% tax bracket (yes, lots of assumptions here...I'm not so much trying to point out the numbers, as I'm showing you how to look at your own numbers); having the mortgage helped you to reduce your taxable income by $2,100...taxed at 25%...that's $525 in your pocket.
Mike and Ann are closer to the 28% federal bracket plus their 4% state obligation. This could be MUCH higher in places like California. So they get a deduction for essentially 1/3 of the interest they pay. They are able to borrow money at 2/3 of the rate published, after taxes. In other words, if their mortgage rate is 3% they are effectively borrowing interest at 2% for 30 years. Interest rate is the price of money. Rates (prices) are exceptionally low right now. Doesn't it make sense to buy low?
Now, I can easily picture a scenario where you would indeed be better off financially, solely because of the tax deduction. You're over the income limit to contribute to a Roth IRA.
Mike and Ann crossed that bridge years ago.
You've completely maxed out your 401k contribution to help bring your taxable income down, but you're still just barely over (we're talking in the low thousands).
Hardly. Mike and Ann make pension contributions but one might have a government defined benefit plan and the other might already contribute to the limit.
If only there was some other deduction you could make, that would reduce your taxable income so you could contribute to a Roth IRA...aha!
Mortgage interest deduction. Take out a mortgage on your primary residence, make sure the interest paid will be just enough to reduce your income to a Roth IRA eligible amount, and pray your boss doesn't decide to give you an end of year bonus.
Um, it doesn't work that way actually.
And no, I'm not gonna say "if you're just throwing away money, might as well give it to a charity, same effect!" because that'd be forgetting all about the cash you got (or freed up) by taking out a mortgage. I'll assume you put that in some kind of savings account or investment vehicle (one that hopefully doesn't make so much money, as to bump your income back over the allowable limits).
Yeah...I'm sure there's other weird crazy circumstances where you'd want a mortgage solely for the tax deduction....but in general it doesn't make sense. I'd look at every OTHER reason for having a mortgage first. Such as...is the interest on a mortgage lower than what can be earned semi-safely (up to you to determine what's "semi-safe"...of course savings accounts qualify, but so would many investments)?
It's not that crazy. And you are actually missing quite a bit of the reasoning. I'll list just a few little things that can come into consideration:
- capital gains on personal residences are tax free up to about $500,000. Capital gains in regular investments and in TIRAs are eventually taxed. (Roth IRAs effectively eliminate capital gains taxes)
- a personal residence converted to a rental can produce passive losses that can offset regular income to some extent. That partially offsets the capital gains advantage mentioned above but these things can be planned and balanced to minimize taxes.
- everyone needs a place to live. You say interest on that $250000 home is $10000 a year. It's probably less because you have overstated the going mortgage rate by about half a percent. But rent on that house would be probably at least $1500 a month or $18000 a year. So property taxes plus interest = $12000 saves you $6000 a year.
- equity in a house earns no return expect possibly through price appreciation. Price appreciation is probably limited to inflation over the long term so your money essentially does not grow.
- Having a fixed rate mortgage gives you inflation protection on housing costs for the most part. Renters are subject to inflation risks. I don't anticipate high inflation any time soon but it should clearly be recognized as a risk.
I completely agree that the math is not the same for everyone and that it usually does not make sense to incur a mortgage for the interest deduction alone. But if I had $250,000 in cash and wanted to buy a $250,000 house I don't think I would want to tie all that money up in a house. I think I would put 20% down, takes out a 30 year mortgage, and invest the remaining $200,000 is relatively safe investments to generate a little more return than the mortgage is costing me. That's not easy right now without taking on risk. But I'm quite confident that in 5-10 years I'll be able to buy low risk assets that pay more than the current mortgage rate. So basically I can buy the money now at cheap prices (low rates) then use it later.
It's not much different than stocking up on tuna when it is on sale. (High five to the first person to identify that reference!)