The home mortgage interest tax deduction isn't all it seems on the surface. You never get back all the interest paid in the last year. It is a deduction, not a tax rebate.
What you get back from the government in mortgage interest allowances is determined by your tax bracket. Most people pay around 30 percent of their income in taxes. That is what you will "get back" from the government for the interest you paid the bank. Simply stated, the lower your tax bracket the lower your mortgage interest deduction is worth. And each year that will decrease even more as you pay off the mortgage and more of your payment goes toward principal instead of interest. For the average homeowner (30 per cent federal and 7 per cent state tax brackets), the mortgage interest deduction works out that for each $1,000 in interest you paid on your home mortgage, you will get back in taxes $370. And that is only if you itemize your deductions.
For more and more Americans, itemizing deductions is no longer a valid option. The 2005 standard deduction for a married couple was $10,000. That means even with a $100,000 mortgage in its first years, you would still have to come up with $3,000 in other deductions just to break even with the standard deduction. Unless your home mortgage is costing you over $10,000 in interest each year, you are getting nothing back for the interest deduction. And then, only 30 per cent of that part that is over $10,000.
Am I against the American Dream? No. What I am saying is that there is a much better way of looking at home ownership than as a mortgage interest deduction. Your home is an investment in equity building. With the cost of today's housing, the traditional 30 year mortgage is almost a necessity for the average home buyer. Without it they can not afford the payments, or the payments put them in a potential financial risk. But, a 30 year mortgage doesn't mean that you have to pay for 30 years.
Your home equity is probably the best investment you can find. It should be your first investment priority. As your income grows or your other expenses lessen, start prepaying your mortgage principal. You will be surprised how fast those thirty years can become twenty or fifteen. Then once the home is paid off, the mortgage payments are free for you to invest elsewhere and you have full equity in your home. For a $100,000 mortgage with a 7 per cent interest, one additional payment in twelve on your mortgage principal will drop a 30-year mortgage by around seven years. The easiest way is to pay a little extra each payment if the money is available. A $100 extra payment each month on the above mortgage reduces a 30 year mortgage by 10 years.
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