Should you pay off your mortgage early? The new tax laws might warrant it.
If you normally itemize your tax deductions each year, you do so because the sum of those itemizations exceed the standard deduction amount that the IRS otherwise provides as the alternative. For instance, in 2017 the standard deduction was $12,700 for married couples. If you were married and had more than $12,700 in itemized deductions then you itemized. If not, you claimed the standard deduction.
In the tax bill that Congress passed earlier this year, the standard deduction doubles from $12,700 to $24,000 for married couples and $6,350 to $12,000 for single taxpayers. This is effective starting this year. It means fewer taxpayers will itemize their tax deductions.
This is where your mortgage comes in.
For many taxpayers, the biggest deduction is the interest paid on a home loan. For some taxpayers it is the only itemized deduction and has historically exceeded the standard deduction by itself. Now, because that threshold has doubled the tax benefits associated with paying mortgage interest will go away if the total interest paid falls short of the standard deduction amount.
Let's use a couple examples...
- You are married
- Your mortgage balance is $500,000
- Your mortgage rate is 4.25%
- Therefore, the approximate interest you will pay in the year is ($500,000 x 4.25%) = $21,250
Result: Assuming you have no other itemized deductions, you would take the standard deduction because $24,000 is greater than $21,250.
- You are single
- Your mortgage balance is $275,000
- Your mortgage rate is 4.50%
- Your total mortgage paid would roughly be: ($275,000 x 4.50%) = $12,375
Result: Assuming you have no other itemized deductions, you would continue to itemize because $12,375 is greater than the new standard deduction amount of $12,000 for single tax filers.
As mentioned, the big assumption in both examples is that there are no other itemized deductions. If there are, such as if you make large charitable contributions, then you will likely continue to itemize.
For the married couple in example 1 above, there is no longer any tax benefit related to holding a mortgage. It is costlier to keep paying interest (in their case, 4.25%) if they have the extra funds to pay off their home loan sooner than the loan term.
There are other variables too. Such as..
- If you are able to leverage your money – meaning make more on your cash than what you pay in interest – then you may prefer to hold a mortgage and invest your excess cash instead.
- The tax laws could change again in the coming years and the standard deduction could be reduced.
- You might not have additional itemized deductions this year, but you could in future years.
- You might not have the extra funds to increase your mortgage payments in the first place.
The bottom line is, if you own a mortgage and have historically itemized your deductions it is at least worth assessing whether you will continue to itemize in the future. If not, consider a plan that involves paying off your mortgage early.
In The Market...
The S&P 500 gained +1.5% this past week. Let's look under the hood:
It was a nice week across the board, as nearly every sector was positive. Health Care (XLV) was up +3.0% and is a sector fund that is now owned within most client accounts. Health Care looks like it could be on the cusp of a nice rally in the coming days/weeks. Technology (XLK) had a nice week as well (up +2.3%) and is a sector that we added to some accounts.
It was an encouraging week, but one that followed two-straight weekly declines for the S&P 500 index. Looking more broadly the overall market continues to see-saw. The S&P enters this week nearly -4% below its previous high, which again is the price level we need it to burst through in order for the rally to resume. Right now the market is coming up on six-straight months of stagnation.
On the bond side, long-term Treasuries, Corporate bonds and Preferred Stock were all up more than +1.0%. We added Preferred Stock (PGF) to many accounts and swapped out our Municipal bond fund (PZA) for Preferred Stock within any IRA accounts that owned muni bonds. The tax-free nature of the interest earned on municipal bonds does not make them as conducive to be owned within IRA accounts, which is why we made the swap to a more growth-oriented bond fund in Preferred Stock. As a reminder, given the characteristics of Preferred Stock we treat it as a bond fund for our stock vs. bond allocation needs.
We are back to being nearly 100% invested as a result of these moves.
In Our Portfolios...
What's New With Us?
My family had a nice trip to Utah for the 4th of July. It is nice to be back for a full week as the market nears its historically most volatile time of the year.
Have a great week,
Brian E. Betz, CFP