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I've read in several articles that a good reason to buy a home instead of renting is that you can deduct mortgage interest on taxes. I don't follow this reasoning though..

If I take a loan so that I can buy a house, I'm paying interest to the bank for giving me that loan. Now getting 25-30% off that interest because of deductions, that makes it a little better.. But I'm still paying more than if I had NO loans at all, which would be the case if i were renting..

What am I missing?

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    I've also heard the deductible interest point used as a reason not to pay off mortgage ahead of time. That doesn't hold water either, does it? – pepsi Aug 1 '11 at 0:42
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    Deductibility is an incentive, not magic dust. You run the numbers and do what makes sense in your situation. For example, if you're 50, in poor health and have 15 years of payments ahead of you, it may make sense to get the loan paid off quickly so you can retire sooner. – duffbeer703 Aug 1 '11 at 3:21
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    just to be certain. You are talking about US tax code, right? – JohnFx Aug 1 '11 at 7:01
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    The deduction just makes the loan cheaper, which is nice. But just another variable in determining whether to buy. – Andy Wiesendanger Aug 2 '11 at 17:59
  • FWIW, the mortgage interest deduction I could get is a fraction of the standard deduction you get by choosing not to itemize. Like most deductions, it only benefits the very-wealthy (or people who buy way more than they can afford), not the rest of us. – R.. Jan 30 '17 at 2:57

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It's not a reason to buy a home, but it is a nice plum that in effect subsidizes your loan in the early years when you pay alot of interest.

EDIT:

Depending on the market that you're in, things like mortgage interest, taxes and insurance are already priced into your rent. Renting lets you avoid the downside risks associated with owning property -- but you also lose the potential upside.

The buy/rent decision is based on the following:

  • Your life. (When you're 23, a house means you're "tied down". When you're 33, it's "stability")
  • Your income/financial condition.
  • The market (for both rentals and purchases)

The market is a huge factor here. I live in a small city (Albany, NY) with a very tight rental market. Renting a 2 bedroom apartment costs like $1,300-1,600 and is difficult to find. But a nice 3-bedroom house in a great neighborhood goes for $150-170k in the city and $180-200k in the burbs. Obviously if you live in the Bay Area, where an empty lot in the hood goes for $750k, ymmv.

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But I'm still paying more than if I had NO loans at all, which would be the case if i were renting..

In this case it really doesn't make sense.

BUT, since the deductible is not only the mortgage interest but also the property tax, then your calculations may change. This by itself is not a reason, it's just another factor in your decision-making.

  • Of course, if you didn't buy, you're also not paying property taxes. – superfell Aug 1 '11 at 2:05
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    @superfell, but you do, it's included in the rent that you pay... – littleadv Aug 1 '11 at 3:12
  • @littleadv - I guess the landlord's mortgage interest is also figured into the rent too. But then again so is the tax deduction that they're getting =p – pepsi Aug 1 '11 at 3:29
  • depends on the market, still much cheaper to rent than buy in the bay area for example. – superfell Aug 1 '11 at 15:36
  • @superfell - not for me (in the Bay area). If you're talking about a 1bd apartment, as what I have - definitely cheaper to buy. – littleadv Aug 1 '11 at 15:47
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One more thing to keep in mind:

Mortgage interest (as well as property tax) is an itemized deduction. What does this mean? When you file your tax return, you have the choice of either deducting the total of your itemized deduction, or taking the standard deduction (for 2011, that's $5,800 if you're single, or $11,600 if you are married filing jointly). If you aren't a homeowner and you live in a state with a low state income tax rate (or no state income tax at all), chances are that your itemized deductions are much lower than the standard deduction.

For example, if you are itemizing your deductions in order to deduct $12,000 in home-related expenses, but you have no other deductions, you are effectively only benefiting on the amount you are deducting above the standard deduction amount. For a married couple in the 28% tax bracket, that would mean a net tax savings of $112 (28% of the $400 above the $11,600 you could deduct in either case).

For higher-income taxpayers, there are limitations on the amount of itemized deductions, as well as limits on the loan amount for which interest is deductible.

Worse yet, Congress has been considering further restrictions on the home loan tax deduction, or eliminating it altogether.

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I don't think you are missing anything at all. You're right: the mortgage interest deduction merely helps reduce the cost of buying a mortgaged home, but it does not in of itself make home-owning an obvious financial win over renting. (Those considerations have been brought up on this site or the famous NYTimes buy vs. rent calculator, etc.)

I, too, (a renter) have been spoken to as if I were "missing out" by not getting that sweet deduction. My attitude has been that at some point I hope to buy a house cash and thereby miss the mortgage interest deduction...because I will pay no mortgage interest at all.

  • Yes, but in the meantime, the cash needed may keep going up. Of course, good timing right now, as the market's not moving. But in general, the balance is b/w cost of the loan vs inflation. And the mortgage deduction just reduces the cost of the loan. – Andy Wiesendanger Aug 2 '11 at 17:57
  • @Andy, to be precise, it's the balance between your cost to borrow (in real terms, i.e. inflation adjusted) versus the opportunity cost of not doing something else with that money. – Mark E. Haase Sep 10 '11 at 17:42
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The normal calculation people make is that if you were to allocate the payments you make for rent to mortgage and property tax payments, you're looking at a nice discount at your marginal tax rate. This is subject to all kinds of caveats that are best addressed by simply running the numbers.

But I'm still paying more than if I had NO loans at all, which would be the case if i were renting..

What am I missing?

The part you're missing is that over time, you build up equity in the home, and you're likely paying someone else's mortgage & taxes if not your own. If you model renting as a perpetual interest only loan, it makes it clearer what the differences are.

There is an argument to be made though that people need to diversify and buying a home often puts you overweighted into real estate.

  • I understand the equity vs no equity argument. The original question was about about interest deductions only. I think the problem is that deductions on interest are often presented as something that you're "missing out on" if you rent, when that isn't really the case. – pepsi Aug 1 '11 at 3:50
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    Well fundamentally, deductions make things less bad, not good. – jldugger Aug 1 '11 at 4:24
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    Another thing to consider is that if you take the standard deduction on your taxes (and many people do) you won't get ANY benefit from this deduction. – JohnFx Aug 1 '11 at 7:01
  • The calculator I linked to above takes this into consideration. If your interest is more than your standard deduction you're just being an idiot by not itemizing. – jldugger Aug 1 '11 at 13:24
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Are you filing the standard deduction, or itemizing?

The standard deduction already includes a mortgage deduction. So buying a house JUST to deduct the mortgage interest seems a little backwards, especially if you end up buying a house that give you LESS than the deduction that the standard deduction would give you.

In my own experience, for awhile we were itemizing, but now we seem to be at the point where the standard deduction lowers our taxes better. We also owe less than $50K right now.

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You would never buy a house just to get a deduction.

If you owe $100,000 on your home and you have a 5% home loan, then you will pay $5,000 a year in interest to the mortgage holder. If you could deduct 30% of that, then you could deduct $1,500. Considering that property taxes, home maintenance, insurance and other associated costs would easily eat the $1,500, it doesn't make sense for the deduction only.

But, if you wanting to buy a home anyway, an extra $1,500 deduction doesn't hurt.

  • Many people would actually get no benefit at all by deducting $5,000 of mortgage interest, unless they have significant amounts of itemized deductions (see my answer) – Tony the Pony Aug 1 '11 at 13:02
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A mortgage interest deduction ENCOURAGES people to buy a home. But that's "all other things being equal." You shouldn't buy a home just for the deduction if it doesn't make sense otherwise.

Basically, it makes sense if your mortgage is slightly greater than your rent. Then the mortgage interest deduction might pull the total below the rent.

But if the mortgage is 1.5 to TWO times what you would pay to rent the same house, you should rent. (And invest the difference, as A.L Williams, an insurance man used to say.)

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Buying a house for the interest deduction is just as ridiculous as buying the pack of baseball cards for that stick of gum.

The rent/purchase decision should look at the cost for each, including the fact that a house has a future cost to sell if you need to move. The mortgage deduction and property tax deduction comes into play, of course, but only when the number are so close that the deduction is a tipping point to make the buy the right thing. But, just as I use the phrase "don't let the tax tail wag the investing dog," there are multiple factors to look at when buying and the small deduction is pretty low on the list.

Consider - A $250K house, so $200K mortgage. The first year, here's $8000 interest. About $4000 in property tax. (Note - the property tax will rise and the mortgage interest fall over time begging the question - Is the property tax deduction really a reason to buy a house). $12,000 total writeoff, and a $3000 tax refund for those in the 25% bracket. Take a moment to ponder this. One is going to make a $250K purchase. Should that $3000 tax refund (What if it were taken out of the tax code, no more deduction for tax or interest) sway this purchase either way?

There are those who would even say that if the $250/month makes or breaks this deal, then you are buying too much house, and getting in over your head.

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It's just one factor in the calculation.

One thing to consider however is that you get the Interest, PLUS property taxes, PLUS any other itemized deductions (sales tax, etc) For some people this might open up several thousand worth of other itemizations that they could not use before, because they were below the standard deduction. (since if you can't get your itemized deductions up above your standard, there's no sense itemizing)

So you need to consider, how much you would pay to rent, vs how much you'd pay in PITI (Principle, Interest, Taxes and Insurance), less the additional money you'd save in taxes, less any equity you build, PLUS market changes to the value of the house, PLUS largely locking in the majority of the payment (mortgage and interest) compared to potentially rising rental costs. LESS the obligation to take care of the place, being 'tied down' when it comes to relocating, taking a year off to travel, or what-have-you.

For some folks, it's simpler and easier to rent. For others buying makes sense, and given the long term overall trend in housing prices in most markets, there can be a substantial return on the value of the property going up over time. (otoh, you have to be able to sit out 'corrections' and events such as the last few years).

for myself, since I bought my current house around 12 years go, I'm still pretty far up in value from when I bought it, AND while rents have gone up substantially, my payments, are close to what they were 12 years ago (lower rates + refiance balanced out increases in taxes and insurance)

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