Embracing change is a big part of being successful, and the new tax plan will likely change many of the financial rules we’ve come to accept.
For example, you’ve probably heard that your mortgage is a “good” debt and it’s best not to pay it off early.
It’s time to ditch that rule of thumb.
Tax Deductible Mortgage Interest
There are many reasons to keep a mortgage. You may want to maintain liquidity for other investment opportunities. You may like that your low fixed rate is a hedge against inflation. You may hope to move soon.
But one of the reasons I most often hear is the tax benefits.
The interest paid on existing mortgages is tax deductible so long as you itemize your taxes.
The problem is most people don’t itemize their taxes. In fact, IRS data shows that a whopping 68.5 percent of Americans usually take the standard deduction.
And that was before the new tax plan increased the standard deduction amount from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples filing jointly.
Courtney Lewis, a Trust Investment Officer at Bank of the Ozarks, noted that “the percentage of people who itemize [their taxes] will drop significantly, since the only reason to do so is if your deductions exceed your now much higher standard deduction.”
This means very few people will be able to deduct mortgage interest from their taxes, and as Lewis pointed out, “For financial planning purposes, for a good size group of Americans there is now a bigger incentive to paying off one’s mortgage . . .”
Will I be taking the standard deduction?
If you’re unsure whether you took the standard deduction last year, TurboTax offers a helpful guide to determine if you itemized.
Lewis described the changes to the tax policy as “interwoven,” so I believe it’s best to have a tax professional determine whether you will be better off taking the standard deduction in the coming years.
But if you usually itemize, line 40 on your previous 1040 forms reveals the total amount of itemized deductions you’ve taken in the past.
Chances are you’re not going to be able to use the tax benefits of your mortgage next year, so does that mean your mortgage is no longer a “good” debt?
I don’t think any debt should ever be labeled as good.
Instead, some debts like mortgages are simply better than others. This is why I wouldn’t think about paying off my mortgage until I had already paid off all my other higher-interest debt including credit cards and car loans.
I’d also want to have a sizable emergency fund and already be maxing out contributions to my retirement accounts.
But once I’ve conquered these, I would absolutely start making payments toward the principal of my mortgage. I know of no other risk-free investment that offers that good of a return.
Adam Lucas holds a Finance degree and an MBA from the University of Kentucky. His work has appeared in many major outlets including AARP.org and GoBankingRates.com.
Courtney Lewis is a Trust Investment Officer – Investment Portfolio Manager at Bank of the Ozarks. Contact her at 501-906-2575.
Please consult a tax professional for your specific situation.
Third party services not endorsed by Bank of the Ozarks.