Good Debt vs. Bad Debt

What you need to know about tax deductions

Managing your liabilities to increase your assets

Many people feel uneasy about mortgages. Our grandparents and parents strived to get away from mortgages and own their homes outright as soon as possible. This general distaste for mortgages is a relic from earlier times when banks could demand a full repayment of a home loan at any time.

Today, mortgages are one of the lowest cost liabilities available to most people. A mortgage is typically tax preferred to other liabilities because its interest is usually tax deductible. While homeowners often think it's best to save money on interest by making extra principal payments, it just doesn't make sense to eliminate the best tax deduction you have -  mortgage interest.

If the government were to pay a portion of your mortgage, how much would you want them to pay?

Interest-only repayment loans can provide you with greater cash flow, higher potential tax deductions, and greater flexibility regarding future loan repayment. Consider the following tax impacts you can use to your advantage:

• Under section 163 of the IRS code, interest on first mortgages is deductible on loans up to $1,000,000, and on a second mortgages or home equity lines up to $100,000.
• This means you could create tax savings on a combined total of $1,100,000.

Another big tax break to consider: If you have lived in a home for the past two years as your primary residence, you can sell the home and take gains of $250,000 per spouse, or $500,000 per couple - tax free.

Small cash flow changes can lead to big results

A fundamental approach to building wealth is to take any savings found from managing your liabilities and use it to increase your assets. The following example illustrates how this is possible:

Assume a couple buys a $400,000 home with 20% down and a 30-year fixed rate mortgage at 6%, with a payment of $1,919 per month. The couple then decides to make a change and move to a more strategic interest-only mortgage. Keeping the same loan balance, they would be able to reduce their monthly payments to $1,133 per month, a savings of $786 per month from their previous mortgage.

The couple could then invest the $786 savings each month, and assuming a 6% rate of return, they will have enough money in their investment account to pay off their mortgage in 19 years - 11 years sooner than their previous 30-year schedule. In addition, they'd also received the benefits of having their cash in a more liquid and safer position throughout the process.

Deferring taxes now can lead to higher taxes later

It's important to understand that your pension, IRAs, and 401Ks will likely be taxed at a higher rate at your retirement. Investing too heavily in these vehicles is counterproductive. You don't want to defer your tax liability to when you're retired because it's a time when you likely won't have significant tax deductions to offset your retirement plan income.

Traditional investment vehicles like IRAs and 401Ks are also surprisingly inconvenient and unduly expensive. You can only set aside a certain amount into these plans, you usually can't touch the money in them without penalty, and when you reach a certain age, you have to start taking money out otherwise you can be penalized.

How equity management can help

Through proper planning a homeowner can use home equity to provide tax-free income during retirement years and allow for more tax-favorable transfer to heirs. This strategy can help substantially increase your net retirement income. Contact us to find out how you can optimize your assets and liabilities.

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