Ask Money

Mortgage tax deduction

Chris Farrell Jun 11, 2009

Question: hey guys. someone had written in with a question recently, asking Chris if they should pay cash up front for a Townhouse, or take out a mortgage.

Chris responded that it was a good idea to start with a mortgage, which could be paid off a couple years down the road if the situation was right, giving the buyer some leeway with their finances. however, what he didn’t address, and what I was expecting to hear, was a comment about the tax implications of having mortgage (aka, being able to deduct interest payments), versus paying cash upfront. so my question is: is it at all worth it to take out a mortgage in this case for the sole reason of being able to deduct the interest payments? thanks. Thomas, San Mateo, CA

Answer: No, I don’t think it makes sense to take out a mortgage because of the interest deduction. What’s more, the advantages of the mortgage interest deduction are exaggerated. It’s a nice benefit for anyone with a mortgage but it’s far from a financial windfall.

For one thing, most couples living outside the most expensive metropolitan areas or the more exclusive neighborhoods around the country can do almost as well taking advantage of the standard deduction. Put somewhat differently, the mortgage interest deduction becomes valuable the higher your income and the more expensive your home. But for most people it isn’t that big a deal. For another, the mortgage interest deduction seems to encourage people to buy a bigger home than they need, and I think that’s a mistake. Most importantly, the debt needs to be repaid and the interest payments add up over time.

So, the real question doesn’t involve the tax deduction. The cash vs. mortgage issue is all about investment opportunity. Does taking out a mortgage let you put the cash into investments that potentially offer a higher rate of return? Is that what you want to do or would you prefer the security of ownership?

My bottom line: Don’t let taxes determine your borrowing and investment strategy. It’s the underlying economics of your household finances that matter. Only then take taxes into consideration.

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