When someone asks us about how to invest, we tell them to first pay off credit card debt because a novice investor is unlikely to do better on their investments than the rate of interest charged on a credit card. If you make ten percent on your invested money you will be losing twenty-four percent on credit card debt you are holding. That comes to a fourteen percent rate of loss. And we suggest that folks put aside enough money for expenses for six months. You do not want to have to bail out of a promising stock investment when it is at a seasonal low because you need to pay the rent. When you are ready to invest we typically suggest that a person buy a home, taking on a mortgage. There are good reasons for this advice. First of all, money you pay for rent goes to someone else. Money you use to pay off a mortgage goes to you in terms of equity in the house or apartment where you live. And interest you pay on your home mortgage is deductible on your state and federal income taxes. You cannot get that sort of deal when investing in stocks, bonds, cryptocurrencies, etc.
How Much is the Mortgage Interest Deduction Worth?
Exactly how much one will save due to the mortgage interest deduction will depend on the interest on the mortgage, how big the mortgage is, the tax rate and your income, which helps determine your top tax rate.
History of the Mortgage Interest Deduction
Once upon a time when they invented income taxes all interest paid was deductible. That went away with tax reforms during the Reagan years. However, the home mortgage tax deduction remained. The rationale has been that making it easier for middle class people to own their own home is a stabilizing factor in society. The result over the years has been that for the vast majority of people their home is their biggest investment. It typically constitutes a nest egg for folks who otherwise have not been investing. Along with Social Security payments, having a home on which they are not paying rent is how many, many retirees get by.
Your Home as the First Part of a Balanced Investment Portfolio
Although owning one’s home keeps many retirees out of poverty, we are not suggesting that one limit their investing to their home. Rather it ought to be the first building block along with an IRA, stocks and bonds. Because mortgage payments essentially replace rent payments as part of the monthly budget they are, to a degree a painless and brainless investment. You should be analyzing other parts of your portfolio but you only need to make payments on your home mortgage. In fact, the steady payments on a mortgage resemble dollar cost averaging as an investment tool. This is an approach in which the person purchases the exact same amount of a stock every month, paycheck or year no matter what the market price. This helps the person avoid buying too much of expense stocks and helps the person buy more of lower priced stocks.
How the Mortgage Interest Deduction Keeps Homeownership Within Reach
We are living in an era in which many young couples are unable to afford their own home and are consigned to paying rent all of their working and retired lives. The mortgage interest deduction is a factor the still makes it easier to purchase your own home. Despite the difficulties of this era for many people, owning their own home is still an excellent goal and, as such the interest deduction is tool to help accomplish that task.
Buying an Affordable Home
Prior to the Financial Crisis too many people were tricked into buying homes that they would eventually lose when the real estate market collapsed and banks raised their rates. During the early years of the century interest rates were historically low and people were able to get into a larger home than they would normally have purchased with the same monthly mortgage payment. Banks offered adjustable rate mortgages which featured attractively low rates at first with the bank having the option to reset the rate as they chose after five years. That is exactly what happened during the Financial Crisis when so many banks were in trouble. The end result was they people were “upside down” on their mortgages. The value of their home had fallen dramatically at the same time that their mortgage had gone up.
Your Home As an Investment
There is no place for wishful thinking in the investing world. This is good to remember when buying a home. When interest rates are historically low is turns out to be dangerous to get into an adjustable-rate mortgage. It is also dangerous to buy the very large home of your dreams as your first home. Commonly people start with something small, have a place to live without paying rent and establish a bit of equity. Then, when their income and other circumstances allow, they move to a larger and nicer home. Common sense is an excellent guide in this regard. Meanwhile, take advantage of the tax deduction offered for mortgage interest as one of best deals in the investing world.