The calculator requires you to enter details about your loan: the loan amount, the term, the interest rate and the closing costs. You also need to know your federal and state tax rates. The calculator then determines your effective tax rate by taking into account how much your overall tax liability is lowered by deducting your state taxes.
If your tax rates are 25% for federal and 8% for state, the calculator determines that your effective tax rate is 31%. This figure comes from taking your total tax rate of 33% (25% federal + 8% state) and subtracting the amount of the state tax liability you recoup by deducting your state taxes on Schedule A (25% x 8% = 2%). You are therefore left paying an effective rate of 31% (33% - 2%).
On a 30-year mortgage for $200,000 with a fixed rate of 6.32%, your monthly payments would be $1,240.55. By the end of the first year, you would have paid $12,573.78 in interest. Provided your loan qualifies for the mortgage interest deduction, you stand to lower your taxes by $3,897.87 ($12,573.78 x 31%).
Say you had to pay a point at closing. When you take that into consideration (points are also deductible in the first year) you end up lowering your taxes by another $620 ($2,000 x 31%), for a total tax savings of $4,517.87 in the first year.
In the second year, your interest payments are slightly lower, as more of your monthly payments go toward paying down the principal of your loan. Even so, your interest payments in year two are $12,423.29, which translates into a tax savings of $3,851.22 (assuming you remain at the same tax rate next year).
You shouldn't decide to buy a house solely on the basis of the potential tax savings, but you should be aware of some of the benefits that decision can have for your financial situation.
Peter McDougall
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