Tax Deductions

What you need to know about mortgage interest

Manage your liabilities to increase your assets

Many people feel uneasy about mortgages. Generations before us, our grandparents and parents, have strived to get away from mortgages and own their homes outright as soon as possible. This dislike of mortgages is a relic from an earlier time when banks could demand full repayment of a home loan at any time.

Today, mortgages are one of the lowest cost liabilities available to most people. A mortgage is typically tax preferred to other liabilities because its interest is usually tax deductible. While homeowners often think its best to save money on interest by making extra principal payments, it doesn’t make sense to eliminate the best tax deduction you have – mortgage interest.

If the government were to pay a portion of your mortgage payment, how much would you want them to pay?

Interest-only repayment loans can provide you with greater cash flow, higher potential tax deductions and greater flexibility regarding future loan repayment. Consider the following tax impacts you can use to your advantage:

• Under section 163 of the IRS code, interest on first mortgages is deductible on loans up to $1,000,000 and on a second mortgage or home equity line up to $100,000
• This means you can create tax savings on a combined total of $1,100,000
• If you have lived in a home for the past two years as your primary residence, you can sell the home and take gains of $250,000 per spouse or $500,000 per couple – tax free.

Even small cash flow changes can lead to big results

A fundamental approach to building wealth is to take any savings found from managing your liabilities and use it to increase your assets. The following example illustrates how this is possible:

Assume a couple buys a $400,000 home with 20% down and a 30-year fixed rate mortgage at 6%, with a payment of $1,919 per month. The couple then decides to make a change and move on to a more strategic interest-only mortgage. Keeping the same loan balance, they would be able to reduce their monthly payments to $1,133 per month, a savings of $786 per month from their previous mortgage.

The couple could then invest the $786 savings each month and assuming a 6% rate of return, they will have enough money in their investment account to pay off their mortgage in 19 years ~ 11 years sooner than their previous 30-year schedule. In addition, they would also receive the benefits of having their cash in a more liquid and safer position throughout the process.

Deferring taxes now can lead to higher taxes later

It is important to understand that your pension, IRA and 401k’s will likely be taxed at a higher rate at your retirement. Investing too heavily in these areas is counterproductive. You don’t want to defer your tax liability to when you are retired because it’s a time when you likely won’t have any significant tax deductions to offset your retirement plan income.

Traditional investment vehicles like IRA and 401k’s are also surprisingly inconvenient and unduly expensive. You can only set aside a certain amount into these plans, you usually can’t touch the money in them without penalty and when you reach a certain age, you have to start taking money out otherwise you will be penalized.

Equity Management can help

Through proper planning, a homeowner can use home equity to provide tax-free income during retirement years and allow for more tax-favorable transfer to heirs. This strategy can help substantially increase your net retirement income. Contact us to find out how you can optimize your assets and liabilities.