The article, “The taxing side of a refinance“ by Marilyn Kennedy Melia, in Sunday’s Rockford Register Star, states the obvious and offers questionable advice.
The basic premise of the article - if you reduce your mortgage interest by refinancing your home at a lower interest rate, you will pay more in income taxes due to a smaller tax deduction for interest paid. Really?
The author then stresses the point by writing,
Come April, though, you may wonder if the hassle of refinancing was really worth it. That’s because shaving interest off your mortgage means you’ll take a smaller interest deduction when calculating your income tax.
Are you kidding? Yes, it’s worth it. You refinance your home to save a bundle in interest on your mortgage payment and then wonder if it was worth it, because you have to pay a little more at tax time. Unless you are in a 100% tax bracket, which doesn’t exist, you will typically receive most of the reduced interest!
The subtitle of the article doesn’t even tell the whole story,
A good refinance will save you money in the long run, but be ready to pay slightly more when you file your taxes.
What did the writer mean – the long run? A good home refinancing at a lower interest rate will save you money the first year, the second year and every year after that and in the long run.
Lets look at the numbers from the example given in the article,
For instance, Fava explains, if you are paying $3,600 less annually in mortgage interest and are in a 20-percent tax bracket, “you’ll be paying $720 more in income tax.” That’s because your taxable income can no longer be reduced by that $3,600, so you’ll pay a 20-percent tax on $3,600, or $720.
What the author didn’t explicitly point out is that the homeowner saves $2880 annually ($3600 – $720 more in taxes) on the principal and interest for the mortgage payment.
The author also reports,
To avoid a nasty surprise, “Figure out what your tax liability will be with the new mortgage rate,” says Karl Fava, a Certified Public Accountant based in Dearborn, Mich.
and follows up with this advice with,
Be prepared for a bigger tax bill by either saving more or adjusting the amount of tax withheld from your paycheck,” Fava says.
Why not accumulate the interest saved – it can even be invested – and pay the higher tax bill from the money ($3600) saved on interest payments, rather than lend the $720, interest free, to the federal government for a year, by having the tax withheld from your paycheck?
Even though the last few paragraphs of the article are confusing, the quoted expert finally gets it right, “The higher tax you’ll pay is much less than the dollars you’ll be saving in interest payments.”
The tax is 20% of the interest saved, but the homeowner gets 80% of the interest saved; can we all say Amen!