Q. If I add an additional amount to my
mortgage payment will it affect my ability to itemize my taxes?
A. That’s
a great question! It correctly identifies that having a mortgage is typically
the dividing line between whether itemizing your taxes is more beneficial than
taking the standard deduction. Most
people with a home mortgage itemize their tax deductions. Most people without a
mortgage use the standard deduction. It is legal to do either each and every
year, but you want to do the one that is most advantageous to you as a
taxpayer. If you have a mortgage it is usually more advantageous to itemize.
Here’s
the short answer to the question: It won’t affect whether itemizing is more
advantageous when you first start to make additional payments, but if you plan
on keeping your house for a long time it might affect you later down the road.
Here’s
why – the part of the mortgage that is deductible from taxes is the interest. The
interest is charged on the principle – the amount you borrowed. When you make additional
payments above the minimum the bank is required by law to apply those
additional payments to reduce the principle. As the principle shrinks the
amount the bank can charge in interest on the loan also shrinks. That’s the
whole point of making additional payments – to lower the total interest you pay
on the loan!
As the
amount of interest you are paying on the mortgage shrinks over time, so does
your tax deduction for mortgage interest. If you significantly shrink your
mortgage interest payments, it might become more advantageous to use the
standard deduction. You always have the ability to itemize, but if your
deductible interest payments are low you might not want to!
There
are other factors in addition to taxes that determine if paying your mortgage
off early is the best course of action for you. Do you have an emergency fund
established? Do you have other debts at higher interest rates (student loans,
car loans, or credit cards)? Do you have access to a retirement plan with
matching money from your employer? It’s never a bad idea to get rid of mortgage
debt, but be sure it is the best move for you to make at this time. If you
aren’t sure, contact a professional financial planner to help you work through
all of the details.
Paul Allen, Bank On Coach and member of Financial Planning Association of Hampton Roads
