Yet Another Mortgage Estimator

The New York Times has a really slick rent-versus-buy calculator; that site has everything you need to compare renting versus taking on a mortgage. I can't recommend it it highly enough.

One thing that the New York Times' calculator confirms is that renting is always better than buying in Silicon Valley. You would need to stay in the same house for about 40 years before it became cheaper than renting for the same period of time.

But "wait!", you say, " you are just throwing your money away when you rent." That is true. But it turns out that housing prices are so high in Silicon Valley, that you actually throw away more money in interest when you take on a mortgage to buy a house (or condo even).

It is at this point someone helpfully adds, "but you can deduct interest from your taxes".

So the questions are:

1. How much money do you "throw away" paying mortgage?
2. And, how much of that do you "get back" from Uncle Sam via the federal mortgage interest deduction tax break?

The first is pretty easy to answer; any loan amortization table will tell you how much interest you pay given a loan amount, interest rate, and number of years you'll be borrowing the money. The second is a little more complicated. Let me explain:

The federal mortgage interest deduction is just that: it allows you to deduct the amount of money you paid in mortgage interest from your income for that year. In other words, it is as if you never made that money. So, if you earn $60,000 in gross income and pay $12,000 in mortgage interest, Uncle Sam will pretend you only earned $48,000 for the sake of calculating your federal income tax.

That wouldn't mean that you get $12,000 off your federal income tax, though; it just reduces the amount of income you have to pay tax on. Meanwhile, you only get to deduct the mortgage interest if you itemize your deductions. This means more work for you in preparing your taxes, but more importantly, it means that you have to give up the "standard deduction". The standard deduction is the amount that everyone is entitled to deduct from their gross income; but you can't take both the standard deduction and an itemized deduction at the same time. So you only want to take an itemized deduction if it would be greater than your standard deduction. For a married couple filing jointly the standard deduction in 2011 will be $11,600.

Going back to the previous example, if you paid $12,000 in mortgage interest you could itemize your deductions and reduce your taxable income by $12,000 or you could not itemize and take the standard deduction of $11,600. With a hypothetical $60,000 of gross income, itemizing would bring your taxable income down to just $48,000 versus $48,400 without itemizing. Obviously, in this case, the itemized deduction leaves less of your money subject to federal tax, so you would want to take that. But it should also be clear that the benefit of the federal mortgage interest deduction is not really $12,000 since, if you didn't have a mortgage, you could still deduct $11,600. So the tax break is really worth the difference between an itemized deduction and the standard deduction...or just $400. But it isn't worth $400 either because it just means that $400 less of your money is taxed; at $60,000 your marginal tax rate would be 15% so the difference in tax is just $400 x 15%, or $60.

That's right, the federal income tax break on $12,000 of mortgage interest is a whopping $60.

The value of the deduction depends on your taxable income and the amount of mortgage interest you pay each year. The amount of mortgage interest you pay goes down as you pay back principle so the value of the tax break also goes down each year.

Anyway, I think you get the idea...calculating the value of the federal mortgage interest deduction isn't trivial. Basically, you have to do your taxes twice, once itemizing to take the mortgage interest deduction and again with the standard deduction, each year, in order to calculate the total value of the tax break.

So I made my own mortgage estimator that approximates the value of the mortgage interest deduction and, factoring that number in, tells you how much money you actually "throw away" on mortgage interest. It also amortizes the after-tax-break interest over the number of months you plan to live in the house, which yields a number comparable to the amount you would "throw away" on rent.

My calculator is here: http://mortgage-estimator.appspot.com/.

The Loan Amount, Interest Rate, and Term fields are used to calculate the amortization table for the mortgage and hopefully are self-explanatory. You can also input the loan amount by entering the Home Price and Down Payment; in which case, how much equity you are putting down is displayed next to the Down Payment as a percentage.

The Gross Income, Filing Status, and Children (actually, dependents) fields are used to estimate your federal tax obligations. The tax estimator is pretty simple; it doesn't know anything about the more obscure deductions nor does it handle investment income, but I believe it is sufficient for its purpose in comparing your hypothetical tax obligation with and without the mortgage deduction.

Finally, the Expected Residency field is an acknowledgement that none of us are likely to live in the same house for the rest of our lives; here you can enter the number of years you expect to live in the home. This is important in the "how much money am I throwing away in interest" calculation because mortgage interest -- like all loan interest -- is front-end loaded. You pay more interest at the beginning of your loan and more principle towards the end. So the fewer years you live in the house before you sell it, the higher your paid interest-to-principle ratio will be.

And now for the minutia:

• All numbers are rounded when they are displayed. So $31.586 will be displayed as $31.59 and $16.134 will be displayed as $16.13; their difference is $15.452 so will be displayed as $15.45 not $15.46. Not that you should expect this estimator to be accurate to the penny anyway.


• The estimator does not currently take into account private mortgage insurance nor FHA loan assistance programs.


• The estimator does not currently take into account state taxes and any possible state-specific home ownership incentives.