Question: My husband and I are in the early stages of looking to buy our first home. Our real estate agent keeps telling us that we can afford a much higher monthly mortgage payment than a rent payment. I understand that the interest is tax deductible but I am unsure as to how to how much money I actually save in taxes. Is there a rule of thumb that I can use to gauge how much money we can save?

Answer: As long as you understand the way a tax deduction works, you should be able to estimate the amount of tax relief you would get from owning a home and holding a mortgage.

First of all, it's important to know what's deductible. In most cases, homeowners are able to deduct the amount of mortgage interest paid in the tax year from their income. They are also able to deduct the amount of real estate taxes paid on the property.

Let me provide an example to illustrate -- and let's keep it very simple. We have a homeowner and a renter with the exact same annual income of $60,000.

The renter pays $1,000 per month and receives no tax benefits from paying rent.

The homeowner holds a $140,000 fixed rate mortgage at seven percent. His total mortgage payment is $1,100 per month. He pays out $1,500 in real estate taxes to the county. He recently received a notice from his lender that says his total mortgage interest paid in the last tax year was $9,755.

Here's the difference between the renter and the owner. The owner can deduct $11,255 ($9,755 plus $1,500) from his income before he calculates his tax liability. The renter must pay his share of income tax based upon $60,000.

Again, to keep things simple, let's assume that they both are in a 25 percent tax bracket. Mr. Renter will then owe $15,000 in taxes to Uncle Sam (25 percent of $60,000).

Mr. Owner's taxable income is only $48,745. He only owes $12,186 in income taxes. This means that our homeowner saves $2,814 in taxes compared to our renter. This amounts to $234 per month.

So, in a nutshell, the homeowner's after-tax monthly payment is $866. The renter is still paying $1,000. At the end of the journey, our homeowner gets to keep the house. The renter has a goose egg.

I'm hesitant to formulate a "rule of thumb" as a tool to help folks determine their deductions. There are too many variables that can greatly change the amount of mortgage interest you pay in a given year. However, perhaps it's safe to say that you can take 20 percent off your mortgage payment to get a rough idea of the tax benefits.

Better yet, a good loan officer should be able to give you a reasonable estimate of your mortgage interest and tax payments over a given period of time.

When it comes to determining your tax bracket and write-offs, consult a tax professional such as a CPA, enrolled agent, or tax attorney. Don't leave that task up to the loan officer.

The bottom line? No matter how you slice it, home mortgages are cheap. If you're tired of throwing away money on rent, home ownership is more affordable today than in many years.

For more articles by Henry Savage, please press here.

Published: September 26, 2001

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