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Financial Literacy

Financial Literacy

Home Finance Taxes Mortgage from a Tax Perspective

Mortgage from a Tax Perspective

Your parents probably complain about their mortgage a lot. And guess what? They're not alone.

Quite simply, a mortgage is a loan that people use to buy a house. Let's say that your parents found a cute house in the suburbs for $300,000. But, after saving for a long time and cashing in some investments and selling some of their Star Wars collector's items, they only had $100,000, so they borrow $200,000 from a bank to pay for the rest. That part's the mortgage.

Getting a mortgage isn't like getting a credit card or car loan, though. The government wants people to buy houses, so they make the interest on mortgages a deductible.

What's a Deductible?

A deductible is something that your parents can subtract from their income when they're filing their taxes so that they pay less in taxes.

Let's say that your parents make $120,000. They pay about 20% in income taxes; we're dealing with graduated taxes, so your folks pay 0% for the first $10,000 they earn, 10% or so for the next $10,000-$20,000, 15% for $20,000-$35,000, and so on (the exact numbers change because the government likes to switch things up like that). But the average is 20% over the entire amount earned per year. That means that they should expect to pay $24,000 in income taxes to keep Washington, D.C. humming along.

But they do have that mortgage for $200,000. They pay 6% interest on it, which means that they pay $12,000 (200,000 x 0.06) a year in interest on that loan. That’s the deductible part. If they claim that on their tax return (and their accountant would turn a very interesting shade of red if they didn't), the government wouldn't charge them 20% on $120,000. They'd charge them 20% on $108,000 ($120,000 – $12,000). The deductible makes it seem as though they never earned that $12,000 that year, meaning that they'd only pay $21,600 in taxes.

That house is saving them $2,400 in taxes each year. That means, instead of costing them $12,000/year the mortgage interest cost them $9,600. If they were really rich, they’d save even more because they’d be in a higher tax bracket and probably dealing with higher mortgages and interest rates.

Bottom line: it pays to own a house. (But, uh, it also costs.)

P.S. You know what else is a deductible? You. Yep, your parents can deduct you from their taxes. Of course, they're shelling out more than you can imagine to raise you, so don't say "you're welcome" quite yet. 

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