Many people know that the interest paid on a mortgage is deductible on their income taxes. But they don’t quite have an idea about the inner machinations.
It really is not all too difficult to understand how tax deductions work, and once you do, you should have a good enough estimate of the tax breaks you could take advantage of by being a mortgage-paying homeowner.
First, you need to know what is deductible. Most of the time, homeowners would be able to deduct from their income the amount of mortgage interest they had paid. They are also able to deduct the amount of real estate property taxes paid on the property.
For example, we have two individuals, one of them rents and the other one owns, and they both earn $60,000 per annum.
Steve pays a thousand dollars rent per month, but does not receive any tax benefits as a renter.
On the other hand, the second individual, the homeowner, holds a mortgage of $140,000, at a 7% fixed interest rate. John’s total mortgage payment adds up to $1,100 monthly. As for property tax, John pays $1,500. For the present fiscal year, John paid a grand total of $9,755 on his mortgage interest — pretty close to an even ten thousand.
This is where taxes will play a very big part in the equation. The owner is able to deduct $11,255 from his income before he calculates his tax liability. Poor Steve — he is not able to deduct anything from his income, so he is taxed on $11,255 more income than John.
We wouldn’t want to flummox you with complicated calculations, so let’s assume both men are in the tax bracket of 25%. The renter, who, once again earns $60,000 per annum, will be charged $15,000 taxes by the IRS. The owner’s taxable income has been reduced to $48,745 after his deductions. Therefore, he would only owe $12,186 worth of income tax for the fiscal year. The owner saves $2,814 in taxes each year. Or on a monthly basis, that’s $234 — not bad at all, eh?
So as you can see, John’s monthly payment after taxes would be, in all actuality, just $866. The renter is still paying $1,000. The homeowner gets to keep his house in the end.
Depending on the variables, you may be paying a different amount of mortgage interest each year throughout the life of loan. But if you want to keep things simple and get a ballpark figure of how much you can potentially save by being a homeowner, simply take off 20% from the total mortgage payment and you have a pretty good estimate.
Your lender should know more. A loan specialist with years of experience would not hesitate to give you a more accurate ballpark of your mortgage interest and tax payments for any given year or time frame within the life of loan. In addition, most lenders should furnish you with a schedule upon closing.
However, the person you would want to ask when it comes to ascertaining tax deductions or your specific tax bracket would be your tax lawyer or CPA. Loan officers won’t really be able to give you a concrete answer to those questions as these are already outside of their demarcation.
In summation, you can save a lot of money if you own a home rather than rent one. Let’s face it – paying rent is a Sisyphean endeavor, so you might actually want to get somewhere and save some funds in the long run by becoming a homeowner instead.
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