From: bd670@cleveland.Freenet.Edu (Russell I. Dyreng)
Subject: Re: 15 year vs. 30 year loans
Organization: Case Western Reserve University, Cleveland, Ohio, (USA)
Date: Thu, 20 Aug 92 17:11:08 GMT


asylvain@felix.filenet.com (The Chipmunk) writes:

>: I think to sum up the whole idea behind paying a 30-year 
>: mortgage in 30
>:    years instead of getting a 15-year mortgage, has been to
>:
>: [...]
>:
>:        2) And, take advantage of the tax deduction for as long 
>:           as possible
>:                (30 years in this case).
>
>Don't forget, the interest portion of the payment shrinks over time.
>
>To take a classic example, the payment on $100k loan at 18% (1.5% 
>per month) is $1507 (and change).  Of that first month, the interest 
>portion is $1500, (1.5% of $100k) and $7 is principle reduction.
>The very next month, it's only 1.5% of $99,993, a little less.
>
>Somewhere between 5 and 10 years, you reach the halfway point, 
>1/2 interest, and 1/2 principle.  It's not linear, so it's not 
>at 15.
>
>By the time you get to around 20, 25 years into the loan, the 
>interest deduction is so small it's almost not worth keeping 
>track of for tax purposes.

Let's take a look at this "classic" example.  First of all, who 
out there is paying 18% on a $100,000 mortgage in 1992?  But just
for the fun of it let's assume that someone is.  If you run out 
amortization schedule for a 30 year fixed rate loan at 18% on a 
$100K principal your minimum monthly payment will be $1507.09.  
You are correct that the first payment will put $7.09 toward
principal, with $1500 going to interest.  But the halfway point
(assuming that you make only the minimum payment each month, 
doesn't occur until the 314th payment, just over 26 years into 
the loan.

Even if you look at a more realistic 8% APR mortgage you won't 
reach the halfway point until payment 257, nearly 21.5 years into
the life of the loan.  After 25 years you are paying about $2700 
in interest annually as opposed to about $7900 annually in the 
first year.

>This is one reason (in my guestimation) that people in America 
>move so frequently ... as the interest tax deduction shrinks, 
>the real cost of the loan grows.  When you move, you get a nice 
>brand new loan, nice and almost fully-deductible again.

If they are moving for this reason then they are in my opinion
penny-wise and pound-foolish.  For every tax deductible dollar
that you spend, you receive a break of $0.15, $.028, or $0.31,
depending on your marginal tax bracket.  The way that our tax 
system is structured it makes it advantageous to be able to 
deduct expenses that you would have to incur anyway, but does
not create any advantage to spend extra money just because the 
expense is deductible.

Look at it this way, if I have paid off my loan to the point 
that I am paying $500 interest monthly and am in the 28%
marginal tax bracket, my actual annual outlay would be $4320.
$500 x 12 = $6000        Interest paid in one year (approx)
$6000 x.28 = $1680       Reduction to income taxes.
$6000 - $1680 = $4320    Net interest expenditure.

Now look at the example where you take out a brand new loan 
so that you are paying lots and lots of interest early on.  
I'll use $1000 per month in interest (average).
$1000 x 12 = $12,000      Interest paid in one year (approx)
$12,000 x .28 = $3360     Reduction to income taxes.
$12,000 - $3360 = $8640   Net interest expenditure.

So here I am spending an extra $4320 for interest so that I 
can take an extra $1680 in tax deductions.  Sure it feels nice
to know that the money isn't going into the hands of the IRS, 
but I would rather have that additional money going to pay off
the loan principal so that in a few years I won't have to make a
mortgage payment.  True, again I'll be paying more in taxes, but 
look on the brighter side, I'll have no mortgage payment to make.
This will allow me to keep more of my money than the tax 
deductions would.

Again to sum up my position:  It's nice that certain 
expenditures which you would normally incur are deductible.  It 
isn't worth incurring unneeded expenditures just because they 
are.

>--
>The Chipmunk.
>Opinions are mine, void where prohibited, taxed, licensed or regulated.
>Stult's Report: Our problems are mostly behind us.  What we have to do
>now is fight the solutions.

Russ
bd670@cleveland.freenet.edu