A Video That Sums Up the Interest Only Conundrum

It's a shame the majority of people think short term rather than long term. The best path to success is to be able to make a sound long-term plan and execute the steps needed to reach it.

The Mortgage Deduction Myth

Picture this: you and I have a mutual friend Tito, who you happen to owe $100. I approach you and offer the following transaction: "I have talked to Tito, to whom you owe $100. If you give me $100, Tito has agreed that he will forgive 35% of your debt! That means you'll only owe Tito $65!"

Would you take this "deal?" It's clear that it's in no one's interest but mine. I get $100. Tito only gets $65. And you? You are now in debt $165 instead of just $100! Yet that's what the mortgage deducation is, in a nutshell. Pay a bank $X dollars in interest and the government will forgive a fraction of that as your IRS debt.

Here's a concrete example: Joe has a $100,000 house with a 6% interest mortgage, making his annual mortgage payment $6,000. (This is rough estimates, since mortgages front-load the interest, but the point still is valid.) Moreover, Joe earns $50,000 per year at his job. Now, Joe faithfully sends his bank $500 a month of interest (plus some principal). When filling out his taxes at the end of the year, Joe gets to deduct $6,000 from his income, meaning he pays taxes on $44,000 (instead of $50,000). Imagine Joe's in the 28% tax bracket - with his tax deducation, Joe would (very roughly) pay $12,320 in taxes. If he didn't have the tax deduction, Joe would have had to pay $14,000 in taxes. Joe saved $1,680!!

But just how did Joe save that tax money? Let's break down the two transactions:

	Amount Paid to Bank	Amount Paid to IRS	Total
With mortgage	$6,000	$12,320	$18,320
With no mortgage	$0	$14,000	$14,000

With a mortgage, Joe's out of pocket expenses for the year were over $18,000. Without a mortgage, Joe was out just $14,000. Doesn't this seem like common sense? Yet many people incorrectly think of a mortgage as some savvy tax move that saves them untold thousands each year. In personal finance, the words "debt" (a mortgage) and "smart move" never, ever go together.

Of course most folks can't afford to buy a house outright, especially with today's overinflated prices. If you have to take out a mortgage, get the shortest term mortgage you can afford so as to reduce the total time until payoff and reduce the total amount of interest paid. Furthermore, lock into a fixed rate instrument (as interest rates have no where to go but up in the forseeable future) and put down as large a down payment as you can.

Don't get flamboozled by the mortgage deduction myth. You are better off having as small a mortgage with as short a payoff time as possible, regardless of what financial experts (mostly lenders, bankers, and realtors) will tell you.