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A booming economy, interests rates finally rising, and tax cuts creating more disposable income have consumers confident and rushing to the malls. However, recessions are inevitable — if not next year then at some point—and trimming debt and shoring up savings during the good times should be a priority.
The new tax law should cause many folks to consider paying off their mortgages but that is hardly best for everyone.
The new law increases the standard deductions to $12,000 for individuals and to $24,000 for married couples, and limits deductions for state and local taxes (SALTs) to $10,000 per return.
Medical expenses in excess of 7.5% of adjusted gross income are now deductible (the old floor was 10%), 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 old 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 European vacation don’t.
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 state income and property taxes of $13,500, 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, 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 the Cleavers, 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 don’t have $250,000 in savings and before accelerating repayments, 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 before retiring housing debt.
If hard times hit and you are over-extended, credit card balances can be more easily renegotiated than mortgage debt. Most student loans, unlike most other debt, are generally 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 are carrying student loans into their middle age and retirement.
Finally, if your home is too small for a young and growing family and are planning an addition or if you have an older home that will need major upgrades like roof and window replacements, interest rates on home-equity loans will be much steeper than most mortgages taken out in recent years. Again it is better to invest extra cash for now than to buy down the mortgage.
I have always advocated 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.
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