One of the side benefits of homeownership is the right to claim various tax deductions, but it turns out that not all homeowners benefit equally.
A new study by the National Association of Home Builders concludes that the biggest benefits go to homeowners under 45, though it depends on the type of deduction.
For many homeowners, the biggest deduction is for mortgage interest payments. Pay $1,000 in interest and you will get $250 back, assuming you itemize your tax return and face a 25% income tax.
But this deduction shrinks over time as the homeowner gradually pays down the loan balance. On a $300,000 fixed rate loan at today’s average rate of about 4.4%, you’d pay about $13,100 in interest the first year, according to BankingMyWay's Mortgage Loan Calculator. That would save you $3,275 in taxes at the 25% rate.
But in the loan’s 20th year, interest would be just under $6,700, reducing the tax savings to $1,675 at the 25% rate. Your monthly payment would be just as large as when the loan was new but more of it would be going to pay down principal.
Using data from 2007, NAHB found the highest average interest deduction, just shy of $14,000, among people 35 to 45. The average deduction gradually declined to less than $10,000 for those over 65.
The study also found that 30% of all interest claimed was found in tax returns of 35 to 45-year olds, compared to 29% for taxpayers ages 45 to 55, 19% for those ages 55 to 65, 7% for those age 65 and older, and 15% for those ages 18 to 35. This is because a large percentage of young people rent or have inexpensive first homes, while many older people have no interest deduction because their mortgages are paid off.
Patterns are similar for the deduction on mortgage insurance, generally required of homeowners whose loans exceed 20% of the property’s market value. Older homeowners are less likely to have this insurance because their loan balances are lower.
The pattern is reversed, however, for the deduction for real estate tax payments. The average deduction nears $4,500 for people age 65 and older, compared to just over $3,500 for people ages 35 to 45, for example. That’s because real estate taxes are based on a property’s assessed value. It doesn’t matter whether there is a mortgage or how large it is.
So what does all this mean?
First, that the mortgage interest and homeowner’s insurance deductions are not lifetime cost savings unless you jump from mortgage to mortgage. For a long-term homeowner, this benefit can shrink to nothing.
Many people assume that deductions support the case for taking out a larger mortgage. That’s not really so. It just doesn’t make sense to pay an extra dollar in interest to save only 25 cents in taxes.
Second, homeowners should be careful not to underestimate the costs of owning a home over time, or the burden they’ll face later in life. Although the mortgage can be paid off eventually, real estate taxes will last forever, and undoubtedly will rise over time.
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