The Mortgage Interest Tax Deduction Myth - Not Every Buyer Benefits!

The Mortgage Interest Tax Deduction Myth - Not Every Buyer Benefits!

Today I got a referral from a past client and had to do some damage control on some of the misinformation the couple's buyer's agent had filled their heads with.

The issue - the agent had told them that because mortgage interest is tax deductible, their $1,000 rent payment compared to a $1500 house payment.

MORTGAGE, EXPERT, MICHIGAN, BIRMINGHAM, BLOOMFIELD, DETROIT, ROCHESTER, ROYAL OAK, TROY

I can only assume the agent was implying that they were in a 33% tax bracket to make that claim.  The buyers were never asked that information.

The bigger issue though was that the agent clearly had no understanding about how the mortgage interest tax deduction works.  They were just abusing a sales technique they'd picked up somewhere and never really learned about.

What did I have to clear up?  Well let's take a look.

Assume the $1500 PITI breaks down like this:

P&I                   - $1,125
Property Tax      - $300
Home Insurance - $75

This about works out for a 5% interest rate on a $210,000 loan.  Let's ignore down payment & PMI for this example.

Now intially this sounds like a fantastic deal.  Can't you just hear the buyers, "wow honey, instead of paying $1,000 for this apartment, we can buy a $210,000 house for the same payment using the mortgage interest tax deduction!"

Well unfortunately, that's not even close to the real story.

Here's how the numbers actually work out.

The first year's interest on the mortgage above would be approximately $10,430.  The annual property taxes would be $3600.

So the total ELIGIBLE for deducting on Schedule A of the 1040 would be $14,030. 

Now the agent in question would probably say that since the buyers were in a 33% tax bracket, they could write off, and thereby save, $14,030 x 33% = $4630.

Not true!

Look at the image of Page 2 of the 1040 tax return below:

Notice that the "Married Filing Jointly" Standard deduction is $11,400.

Line 40 of the 1040 states, "(from Schedule A) or your standard deduction Itemized deductions".

What this means is that the buyers get an $11,400 tax deduction whether they own a home or not!  The only time you'd put your Schedule A total on line 40 would be if it exceeded $11,400.

So the couple's actual benefit from owning the home in this example would only be:

                 $14,030 - $11,400 = $2,630 x 33% = $867

A drastic difference from what their agent had ignorantly misled them with.

I've seen mortgage people make a version of this mistake also by telling clients, "that 5% interest rate is really 3.35% after taking into account your 33% tax bracket." (that's 5% x (1-0.33))

Keep in mind that our example was based on a $210,000 mortgage.  I've heard agents using this same technique on deals under $100,000 - where the buyer wouldn't realize any additional tax savings whatsoever.

The true professionals in our industry really need to know the facts about tax deductions to avoid making any misleading statements. 

The best way to handle the issue is to recommend that your buyers take the tax deduction savings issue up with their CPA.  If they don't have a CPA, you could easily refer them to YOUR trusted CPA partner to earn some reciprocal referrals from them.

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Drew Sygit: CMPS, CMC, CRMS, CMLO, CALO, MBA, NAMB/MAMP Instructor & Speaker
The most Certified Mortgage Expert in the Midwest

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P: 248-356-3739 • F: 866-215-3755 • dsygit@TheLendingEdge.com • www.TheLendingEdge.com