© 2015 Shmoop University, Inc. All rights reserved.
Financial Literacy

Financial Literacy

Under Water

One of the big buzz words you’ll hear in housing crises areas is “under water” – it means that the mortgage is worth more than the market value of the house. To wit, your $500,000 home was purchased with $50,000 down and a mortgage of $450,000. That mortgage carried at the time a historically low interest rate of 6% - so you were paying $27,000 a year in mortgage payments. But those payments – the interest, that is – was entirely deductible off of your ordinary income taxes.


Because it just is. It’s how the country sprayed WD-40 on the tracks of those chugging along in pursuit of The American Dream.

So for a UPS driver married to a school teacher paying a marginal tax rate (the highest tax you pay on a graduated tax system) of 30%, it means that:

0.3 x $27,000 or $8,100 of the $27,000 “is paid by the government.”

Said another way, if you filed your annual income as a married couple who pays taxes together as one unit (called: “married, filing jointly”) and you were paying taxes on $127,000 a year in income, the income you pay taxes on is just $100,000. The $27,000 essentially comes off the top and goes away as something you’d have to pay taxes on.

With $27,000 going away, you’ve saved $8,100 in taxes, so the $27,000 “feels like” $18,900 in after tax payments, just as Tuesdays sometimes feel like Wednesdays. More or less, it is the equivalent of you renting an apartment for $18,900 a year or a skosh over $1,500 a month.

So why not rent? Every time the kitchen sink clogs, I can call someone and it will be magically fixed for no extra charge. What’s so special about a house?

What’s so special is that, in this case, you get to own a half a million dollar home. And the half million dollar home goes up in value.

In theory. Remember homes don’t only go up in value any more. So… does that mean that it is better to rent?

People who Shmooped this also Shmooped...

Noodle's College Search