What Size Mortgage Exceeds Standard Deduction?

by Kevin on July 15, 2010

In my last post I showed you that for many people the mortgage interest deduction alone doesn’t save you any money on taxes. This goes against the commonly touted “benefit” of a tax break for having a mortgage.

I also said I would show what size mortgage is needed to fully cover the standard deduction for filers that file married filing joint.

To Exceed the Standard Deduction, Your Mortgage Must Be…

Assuming your interest rate is at 5% like the examples in the original post your mortgage must be $221,484 for your mortgage interest to exceed the standard deduction.

If you put 20% down that means your home price would be $276,855.

That’s a lot of house where I come from. In other cities that might be a decent middle class home. I guess it just depends on the area.

But remember the most interest you’ll pay (on an annual basis) is in the first year.

So with a mortgage at that size you will cover the standard deduction the first year, but your interest will slowly drop over time. At the same time the standard deduction will probably rise over time as well.

Other Factors to Consider Before Paying Down Your Mortgage

The potential tax break you get from paying mortgage interest should never be the only factor you consider when deciding to pay down your mortgage.

You must consider the rest of your financial situation.

  • Do you have an emergency fund? You need to have 6 months of cash on hand for emergencies. Putting money into your home makes it very illiquid and difficult to access in an emergency.
  • Have you received the company match on your 401k? If you are sacrificing all of your retirement savings to pay down your mortgage, reconsider. At least put in enough money to get the company match. Every dollar you put in will be matched 100%. That’s 100% return and free money!
  • Do you have other debts at higher interest rate? If so, pay those off completely first. Always pay the higher interest rate debts first.
  • What is your timeline to retirement? It may make more sense for you to be hoarding cash for retirement. (And probably selling that house, too.)
  • How much risk you take with investments? If you take big risks — and hopefully enjoy big rewards — then your money may be better off invested. For example, if you could earn a 12% return every year then paying down a 5% mortgage is taking a much smaller return on your money.

What else should you consider before you sink money into your mortgage?

{ 4 comments }

Petunia July 15, 2010 at 11:33 am

I think everybody ought to work on developing at least a general outline of their own financial plan, and then consider how any particular decision fits into that plan. While this sounds rather obvious, I blush to think how long it took me to figure this out.

Golfing Girl July 15, 2010 at 8:39 pm

I think you hit the major bullet points to consider. The only one I’d add might be “Are you maxing out your Roth IRA?” contribution (for those who are eligible and only because any contributions can be withdrawn without penalty so it can double as an emergency fund). Myself, I don’t “count” my Roth in my emergency fund, but it’s nice to know it’s there.

I think the last bullet is the most important. Be honest with yourself–don’t say that you can tolerate risk but get heartburn when you open your 401K statement and see that it’s been a down quarter (like this past quarter). If you’re looking for a GUARANTEED return, then this is your best bet–plus you can easily calculate it! Mine is 5.5%–not too shabby and beats the CD and money market rates right now. 🙂

Budgeting in the Fun Stuff July 20, 2010 at 2:32 pm

I agree with Golfing Girl. We’ve overpaid our mortgage by $160 since we got it in 2007, but we haven’t put anything else towards it yet because we wanted to get the maximum company match on my 401(k), which is 6%, AND we wanted to max out at least one Roth IRA every year.

Now that we’ve met all of the rest of the criteria, we’re building back up our emergency fund and then increasing our principal payments. 🙂

Greg July 25, 2010 at 12:50 pm

I would add college savings ahead of (or at least in conjunction with) paying off the mortgage. Student loan debt is a terrible way to start a new phase of life so our goal is to accumulate $0 student loan debt, during the college years.

Totally agree with all other points.

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