Morici: Paying off the mortgage, but not too quickly

Peter Morici

The new U.S. tax law simplifies April 15. Many folks will be claiming new higher standard deductions instead of itemizing mortgage interest and the like, but folks should not rush to pay off their home loans.

Congress increased standard deductions for individuals and married couples from $6,500 and $13,000 to $12,000 and $24,000 respectively, and limited deductions for state and local income, sales and property tax deductions (SALTs) to $10,000 per return.

For single individuals, with SALTs totaling close to the $10,000 limit and substantial mortgage interest payments, itemizing deductions can still make sense – especially those with large mortgages, high medical costs or significant charitable deductions.

Medical expenses in excess of 7.5 percent of adjusted gross income are now deductible (the old floor was 10 percent), casualty losses are no longer deductible unless incurred during a federally declared disaster, and interest on mortgages up to $350,000 for single taxpayers and $750,000 for married taxpayers is deductible. On loans taken out before Dec. 15, 2017, the older limits of $500,000 and $1 million apply.

Only mortgages obtained to purchase or substantially improve a residence count – home-equity loans to fix the roof or take a Caribbean vacation do not. A home-equity loan to air condition a previously hot-in-the-summer dwelling should count.

If Sally and Jim live together unmarried in a home Sally owns, she pays $10,000 in interest on a $250,000 mortgage and pays SALTs of $13,500 (including $4,000 in property taxes), Jim pays $9,500 in SALTs, and each donates $1,000 to charity, Sally should take allowable itemized deductions equaling $21,000. Jim should take the standard deduction of $12,000.

Now suppose Jim and Sally decide in favor of wedded bliss (no fair older folks telling them tales of mid-life crises and divorce), then their taxes go up.

Although single taxpayers may take deductions for SALTs up to $10,000, married taxpayers filing separately only get $5,000 each. Hence, Sally’s allowable deductions are cut to $16,000, and Jim should now itemize allowable deductions of $6,000. The marriage would cost them $11,000 in combined deductions, and they would likely pay at least $2,000 in additional taxes.If Sally accounted for most of their combined income, filing jointly and taking the standard deduction could make sense, but they should be cautious about paying off the mortgage too quickly.

At the extreme are Ward and June, a married couple with a single-wage earner but the same combined numbers as above. Their SALTs deductions are capped at $10,000, their total allowable itemized deductions are $22,000 and they should take the $24,000 standard deduction.

The tax savings on mortgage interest will be gone – depending on their tax bracket that is likely in the general range of $2,000 – but they too should be cautious about rushing to pay off their mortgage.

Most folks do not have $250,000 in savings and before accelerating repayment, they should max out contributions to tax-sheltered retirement plans at work. Regular payday investments in an index mutual fund will likely leave them much better situated 10 years from now.

Mortgages initiated in recent years offer just about the cheapest money ordinary working folks will ever borrow, and it’s better to first pay down credit card and student loans balances.

If hard times hit, you are out of a job and over-extended, credit card balances can be more easily renegotiated than mortgage debt. Student loans, unlike most other debt, are not dischargeable in bankruptcy.

Lots of folks lost homes in the financial crisis, got absolved of some credit card debt and residual mortgage balances on properties sold for less than their mortgages, but they are carrying student loans into their middle age and retirement.

Finally, if you own an older home and are facing big maintenance expenses – for example, furnace, air conditioning, roof and window replacements or repair – that will require a home equity loan or some other financing, the interest rate on those will be much steeper than most mortgages taken out in recent years.

I have always counseled getting out of debt but carefully pay off the most burdensome debt first. Accelerating mortgage repayments can make sense, but you need to save for retirement and have spare cash for contingencies. With CDs paying decent rates again, do the math.

Peter Morici is an economist and business professor at the University of Maryland, and a national columnist. © 2018, The Washington Times, LLC.