What about Taxes and Your Second Mortgage? Interesting Things to Consider

For the typical buyer who has managed to acquire credit card debt, auto loans, and a variety of other small debts, is the second mortgage loan an answer for the consolidation of debt and a tax reduction? Rather often the answer to this question is yes. Second mortgages that have traditionally been used in areas of home improvement, funding college educations or business startups are now being considered as a means to reduce or consolidate high-interest credit card debt and create a tax deduction all at once.

For the typical consumer, using second mortgage loan money to pay off credit card debt or to consolidate individual personal loans does not reduce the possibility of a tax reduction; in particular if that average consumer does not already own a second home. The only difficulty here seems to be that we’re replacing credit card debt for second mortgage debt; what do we then do with the credit card we’ve paid off? The smart buyer cuts them up.

How does a second mortgage affect your tax liability at the end of the year? Lots of that will depend on your income levels, your medical expense, and your other interest deductions. Mortgage interest expense is deductible on the Schedule A “Itemized Deductions” form of your individual or personal tax return. The Schedule A, however is not a straight tax reduction tool. Tax reductions, or deductions, carried forward from the Schedule A are a percentage of your AGI, or your adjusted gross income. Your adjusted gross income is based upon your income less certain expenses and deductions from Schedule Cs, Schedule Es etc. Can you now see where this might be a little complicated?

Let’s throw something else into the mix: if you’re an investor, in particular in the real estate market, your mortgage interest may not be deductible, period. Mortgage interest on your first home and on your second home is a tax-deductible interest; if however, you happen to be an investor in the real estate market the ability to make it clear distinction between first and second homes vs. investment property becomes much harder to prove. Is the home a second home with deductible mortgage interest expense, or is it an investment? Certainly, for investors interest expense on a loan for investment purposes is completely tax deductible; no percentages to work with at all.

Now let’s ask one more question, if you come to a decision to take out a second mortgage could you better invest your money? What a 401(k), an IRA, or an MSA be a better benefit when it comes tax time v leading the money in your home as equity? This has been a question long debated by financial analysts, tax attorneys, and quite tax proficient homeowners. How does the equity better serve the homeowner? As a savings account, which is really what the equity in your home turns out be, or as an investment tool that can be used to boost your retirement savings? There are other factors to be considered here: such as penalties for early withdrawal, risk ratio versus profitability ratios, and which programs lessen tax on a one-to-one ratio? Unless you already have some general understanding of the tax system, it can be more expensive to determine tax savings than you would actually save.

As you can see there are lots of, many ways to affect your tax liability, your tax deductions, or affect a tax reduction; the right answers are highly dependent upon the individual situation and the individual objectives. The only way to accurately determine the better advantage is to sit down with a financial advisor, your tax information, and estimate your long-term objectives.

Does the average consumer ever take the time to accomplish this? As a general rule the answer is no. The majority of consumers never take the time to look past next month. Over the course of a stressful and hard work week retirement planning, tax deductions, and income producing benefits never cross the consumer’s mind. For those folks who truly anticipate and receive benefit from tax planning in relation to their mortgage interest, there are many more folks who never even contemplate that there might be a savings. Maybe, we should just omit this question.

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