The government just passed the Tax Cuts and Jobs Act on December 22, 2017. This bill changed the amount you’re allowed to claim in interest deduction and also eliminated the home equity loan interest deduction. You’re now able to deduct interest on a loan of up to $750,000 for a primary residence in 2018. That’s down from $1 million in prior years. I know what most of you’re thinking: “This doesn’t affect me!” But the new tax bill does affect you. The standard deduction amount will almost double for the 2018 tax year. This means that a lot of people who previously itemized their mortgage interest for deduction will no longer be able to.
Here’s an example: A family has itemized deductions of $15,000 in 2018. $10,000 in mortgage interest, $4,000 in property taxes, and $1,000 in charitable contributions. The new tax bill allows for a family to deduct $24,000 as the standard, non-itemized deduction. This family will take the standard deduction because it’s higher than their itemized deductions. Therefore, there is no value in the mortgage interest deduction.
I’ve always questioned the value of the mortgage interest deduction. Sure, you can deduct your mortgage interest but you probably would have done just marginally better over the standard deduction. Under the old tax code, if you had itemized deductions of $14,700 but your standard deduction was $12,700, the value of itemizing your deductions was a measly $2,000. That’s hardly worth the hassle. Now with the new tax code a family’s itemized deduction increases to $24,000, making the mortgage interest deduction (and all other itemized deductions less valuable) less valuable.
Even though the mortgage interest deduction is now less valuable, that doesn’t mean you should go paying off your mortgage early. I still believe that many upper-middle class and upper class should carry a big long-term mortgage in retirement. There’s still a huge value in carrying a mortgage instead of paying it off.
This is what you should do instead of paying off your mortgage: Invest the amount that you would have otherwise put toward your mortgage. Here are some different investment options if you’re a DIY investor. The reasons for investing instead of paying off your mortgage are vast:
1) Interest Rate Arbitrage – You will likely earn more on your investments than the cost of your mortgage. The market went up over 20% in 2017 and since 2009 has gone up over 300%. Even if you’re not fully invested in equity (stocks), you should still do better than 3 – 4%, which should be the cost of your mortgage. If you have a high mortgage rate, you should refinance immediately.
2) Optionality – You will have many more options if you invest than if you pay off your mortgage. Having your money in an investment account keeps it liquid. You can use the money if you need to. Maybe you want to withdraw the interest. Maybe you want to go on a vacation or put a new roof on the house. Having your money in investments makes it easier to get to. No one needs to “approve” you for an equity line of credit. It gives you a lot more freedom.
3) Risk Transfer – When you payoff your mortgage, you transfer the risk of loss from your bank to you. The mortgage company requires that you hold insurance on your home. They do that to protect their investment (your house). They don’t require you to carry insurance out of the goodness of their heart. No, they want to make sure they’re protected from loss. This makes sense. When you payoff your mortgage, you carry the risk of loss. That includes loss from disasters as well a drop in the market. You can insure yourself against disasters for the most part but you can’t insure against the value of your house going down.
4) Liquidity Risk – You’ve heard the term “house poor” before. That’s a term that means you spend too much as a percentage of your income on your housing expenses. There’s also an issue of having too much of your net worth as equity in your home. Equity is a non-liquid asset. It doesn’t grow in value – your home grows in value, not your equity. Sure, your equity increases but not because it’s an investment. It grows because you either pay your mortgage down or your home value increases. There’s much more value having $200,000 in an investment account than having it in equity in your home.
5) Inflation Hedge – By having a mortgage balance on a property instead of paying it off, you’re effectively shorting the dollar. This is a good move and has been a good move for over 100 years. The value of the dollar goes down over the long-term. This is due to inflation, which is one of the two mandates of the Federal Reserve Bank. They actually target 2% inflation because they think slight inflation is good for the economy.
I’m investing my money instead of paying off my mortgage and I think it might make sense for you to do the same. I’m on track to be able to pay off my mortgage in the next 3 – 4 years but I won’t. Instead, I’ll keep investing the proceeds for the long-term but I’ll always have the option to pay it off in 24 hours if I change my mind. That’s the optionality that investing your money gives you.
Some people feel strongly about paying down all their debt, even their mortgage debt. I’m not trying to change your mind if you believe that all debt is bad. Most people don’t regret paying off their mortgage debt; it’s just not as financially optimal. I think you’ll do better by investing instead of paying off your mortgage debt, even under the new tax bill.