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Don't Go Crazy Just Because Mortgage Interest Deduction Was Saved

Buying a home does make sense because you need a place to live, and owning can be less expensive over the long term than renting. But from a purely financial perspective it pays to buy the cheapest home that fills your needs rather than the most expensive one you can afford. Savings on the cheaper home can then be invested more profitably.

The mortgage interest deduction, while valuable, is not as valuable as many think. It offers tax savings only to those who have enough deductions to justify itemizing them on the federal return. Homeowners who don't itemize get nothing from the mortgage interest deduction, despite paying lots of interest.

And even those homeowners who do itemize benefit only if the interest deduction pushes their total deductions higher than the "standard deduction" available to everyone. For 2013, the standard deduction, which the IRS will announce soon, is expected to be $6,100 for individuals and $12,200 for married taxpayers filing a joint return.

In other words, a married couple with no other deductions would benefit from the mortgage interest deduction only if their interest payments exceeded $12,200, because they'd be entitled to the $12,200 standard deduction anyway if they did not itemize.

If they paid $15,000 in interest, the mortgage deduction would garner them an additional deduction of only $2,800. That would save them just $700 in taxes if they were in the 25% tax bracket, not the $3,750 they might expect for paying $15,000 in interest. They'd save the full $3,750 only if their other deductions totaled at least $12,200, making the entire mortgage interest payment deductible.

This isn't to say that the mortgage interest deduction isn't worth having. It's just that, in itself, it's not a good reason to take out a larger mortgage. After all, even if the entire interest payment is deductible, it doesn't make sense to pay an additional $1 in interest just to save 2 cents in taxes.

Happily, there are other reasons to buy a home, and the risk seems to be diminishing as the market improves and Washington finally resolves the uncertainty surrounding taxes.

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