Not itemizing: effective mortgage rate
Not itemizing: effective mortgage rate
For two years we haven't itemized on Federal because deductions didn't exceed the standard deduction. If my marginal tax rate is x and mortgage rate is r, isn't the effective mortgage rate ef = r/(1-x)? I think this is the number I should compare to potential investment returns when deciding to accelerate the mortgage payoff vs invest. Seems to me not itemizing makes accelerated mortgage payoff more attractive. Is my thinking sound?
Fyi, accumulation phase is done (i.e. retired), so $ aren't competing with 401k/IRA contributions.
Fyi, accumulation phase is done (i.e. retired), so $ aren't competing with 401k/IRA contributions.
All we want are the facts...
Re: Not itemizing: effective mortgage rate
If you don’t itemize, your effective mortgage rate and actual rate are both r. You are receiving no tax saving. Yes, not itemizing clearly makes mortgage payoff more attractive.
Gill
Gill
Cost basis is redundant. One has a basis in an investment |
One advises and gives advice |
One should follow the principle of investing one's principal
Re: Not itemizing: effective mortgage rate
What Gill said if you don't itemize.
If you do itemize, and other itemized deductions add up to the standard deduction or more, the after-tax mortgage rate is r * (1-x).
That is the same as the after-tax interest rate on a savings account paying interest rate i: i * (1-x).
If you do itemize, and other itemized deductions add up to the standard deduction or more, the after-tax mortgage rate is r * (1-x).
That is the same as the after-tax interest rate on a savings account paying interest rate i: i * (1-x).
Re: Not itemizing: effective mortgage rate
For the amount of mortgage interest above the standard deduction, adjusting for SALT and other deductions...FiveK wrote: ↑Tue Dec 07, 2021 10:05 pm What Gill said if you don't itemize.
If you do itemize, and other itemized deductions add up to the standard deduction or more, the after-tax mortgage rate is r * (1-x).
That is the same as the after-tax interest rate on a savings account paying interest rate i: i * (1-x).
That's why I think one should calculate three mortgage rates: nominal, effective, and marginal since for most folks the other deductions don't usually go over the standard deduction amount.
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Re: Not itemizing: effective mortgage rate
But as long as you itemize, the marginal rate will tell you whether it's worth paying down the principle a little bit. You should make this decision for each dollar you pay down separately.mervinj7 wrote: ↑Tue Dec 07, 2021 11:29 pmFor the amount of mortgage interest above the standard deduction, adjusting for SALT and other deductions...FiveK wrote: ↑Tue Dec 07, 2021 10:05 pm What Gill said if you don't itemize.
If you do itemize, and other itemized deductions add up to the standard deduction or more, the after-tax mortgage rate is r * (1-x).
That is the same as the after-tax interest rate on a savings account paying interest rate i: i * (1-x).
That's why I think one should calculate three mortgage rates: nominal, effective, and marginal since for most folks the other deductions don't usually go over the standard deduction amount.
Re: Not itemizing: effective mortgage rate
That's right. I usually tell people to look at their marginal mortgage rate for partial prepayment of the mortgage and their effective mortgage rate for full payoff considerations. For example, my marginal mortgage rate is 1.87%, so it's really hard to justify paying extra on the mortgage each month like I used to. Even if I weren't comfortable investing extra funds in equities, I should at the very least be putting extra payments into I-bonds instead.AnEngineer wrote: ↑Wed Dec 08, 2021 8:34 amBut as long as you itemize, the marginal rate will tell you whether it's worth paying down the principle a little bit. You should make this decision for each dollar you pay down separately.mervinj7 wrote: ↑Tue Dec 07, 2021 11:29 pmFor the amount of mortgage interest above the standard deduction, adjusting for SALT and other deductions...FiveK wrote: ↑Tue Dec 07, 2021 10:05 pm What Gill said if you don't itemize.
If you do itemize, and other itemized deductions add up to the standard deduction or more, the after-tax mortgage rate is r * (1-x).
That is the same as the after-tax interest rate on a savings account paying interest rate i: i * (1-x).
That's why I think one should calculate three mortgage rates: nominal, effective, and marginal since for most folks the other deductions don't usually go over the standard deduction amount.
Re: Not itemizing: effective mortgage rate
You do have to keep in mind that the effect of deductibility of mortgage payments only applies to the amount above the standard deduction.
Say your mortgage interest makes your total itemized deductions $1 above the standard deduction. Yes, FOR THAT DOLLAR the effective mortgage rate is reduced by deductibility. Say it saves you 32 cents. The effect on your finances would be trivial. It would be misleading to think that your entire mortgage interest payments should be viewed as if they were reducing your taxes. Only the amount above deductibility will do that.
Say your mortgage interest makes your total itemized deductions $1 above the standard deduction. Yes, FOR THAT DOLLAR the effective mortgage rate is reduced by deductibility. Say it saves you 32 cents. The effect on your finances would be trivial. It would be misleading to think that your entire mortgage interest payments should be viewed as if they were reducing your taxes. Only the amount above deductibility will do that.
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Re: Not itemizing: effective mortgage rate
How does one compute marginal mortgage rate?
Seems to me what I said in my original post that r/(1-x) where r is my mortgage rate and x is my marginal tax rate, is the best way to compare my mortgage situation (i.e. no itemizing) to a taxable investment.
Seems to me what I said in my original post that r/(1-x) where r is my mortgage rate and x is my marginal tax rate, is the best way to compare my mortgage situation (i.e. no itemizing) to a taxable investment.
All we want are the facts...
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Re: Not itemizing: effective mortgage rate
Exactly, this is why I think looking at effective rates can be misleading. It only compares two points. It's possible that paying off the entire mortgage is better than paying according to schedule, which you'd know by looking at the effective rate. However, it doesn't tell you that paying it down partially may be even better, which is why looking at marginal rates is important.afan wrote: ↑Wed Dec 08, 2021 11:35 am You do have to keep in mind that the effect of deductibility of mortgage payments only applies to the amount above the standard deduction.
Say your mortgage interest makes your total itemized deductions $1 above the standard deduction. Yes, FOR THAT DOLLAR the effective mortgage rate is reduced by deductibility. Say it saves you 32 cents. The effect on your finances would be trivial. It would be misleading to think that your entire mortgage interest payments should be viewed as if they were reducing your taxes. Only the amount above deductibility will do that.
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Re: Not itemizing: effective mortgage rate
I figured that's what you were trying to do. But, calling that your effecrive mortgage rate is not accurate.
A 3% mortgage with no deduction is a 3% mortgage. It might be the same as a 4.25% taxable investment but your effective mortgage rate is 3%. If you want to adjust anything, adjust that taxable investment down to an after-tax return.
Re: Not itemizing: effective mortgage rate
As I posted above, if you are not itemizing your marginal mortgage rate is equal to the nominal or actual mortgage rate. When you compare that to a taxable investment you subtract the marginal tax rate from the income to compare with the mortgage rate. As an example, if your mortgage rate is 4% you are losing by carrying an investment earning 5% but which is taxed at 25% and therefore yielding 3.75% after tax.
Gill
Edit: Dukeblue beat me to it with a similar example.
Cost basis is redundant. One has a basis in an investment |
One advises and gives advice |
One should follow the principle of investing one's principal
Re: Not itemizing: effective mortgage rate
OK, looks like my thinking was basically sound (i.e. how to compare my mortgage rate to a taxable investment) but used incorrect terminology. To me the end result is the same whether I compute an equivalent mortgage rate based on no tax benefit or compute the after tax return of a taxable investment as long as I can keep them straight. Thanks for the replies.
All we want are the facts...