Don't Go Crazy Just Because Mortgage Interest Deduction Was Saved
NEW YORK (BankingMyWay) -- Now that we've dodged the bullet and the fiscal cliff debate is behind us, it's time to think seriously about that new home you've wanted.
The deal approved this week leaves intact the homeowner's mortgage interest deduction, which makes a home purchase more affordable. There had been some talk of modifying or eliminating that tax break for homeowners, and though the idea never got a lot of traction it was enough to make a prospective homebuyer hesitate.
So, to be clear, here's how the deduction works: You can subtract from your taxable income the interest paid on up to $1 million in mortgage debt. That maximum applies to the total amount of debt on a first and second home. Had there been a change, the deduction on a second home seemed particularly vulnerable, and there was some talk of reducing that $1 million limit.
This good news comes on top of a series of positive reports about the health of the housing market. Prices have been rising, more homes are being built and the prospects for a new plunge in home values are diminishing by the day. With the uncertainty over tax rates resolved for the long term, it's much safer for homeowners, builders, employers and lenders to place their bets. That could propel improvements in the broad economy that would reduce the risk of a home purchase.
But let's not go overboard. You won't find any experts predicting a home-price boom like the one in the middle of the last decade. While there may be hot markets here and there, it's just not possible for home prices to rise faster than incomes indefinitely, because at some point there are not enough people who can afford those pricy homes. Many of the people who ignored this fact and bought at the peak a few years ago are still deep underwater, owing more than their homes are worth after prices collapsed.
Over the long run, home prices rise at about the inflation rate, which averages around 3% a year. Add interest charges, taxes, maintenance, insurance and other costs of ownership and a home is likely to be a money loser. Even if it does turn out to be a profitable asset, it's unlikely to beat alternatives such as stocks over the long term.
Buying a home does make sense because you need a place to live, and owning can be less expensive over the long term than renting. But from a purely financial perspective it pays to buy the cheapest home that fills your needs rather than the most expensive one you can afford. Savings on the cheaper home can then be invested more profitably.