Paying interest to save on taxes. AKA, should you trust financial advisors?

[Rich M]

I know a lot of friends who say that it's so good to have a large mortgage on the house they live in because it's tax deductable.  They also leverage home equity loans to buy cars and think they are saving tons on taxes with the deducted interest.

Did I miss something in the math here?  Seems every time i run the numbers, I see it as paying a dollar to maybe get 30 cents back.  And it's worse than that because the first few thousand dollars of interest is already included in a standard deduction.

And buying a car on a home equity loan?  I mean, when I was looking at loans many years ago, at the moment, the home equity loan rates were higher than the car loan rates.  And we already know MMM's view on borrowing to buy a car.

These people also tout how this was explained to them by a financial advisor.  These were the same advisors in 2005, telling them to leverage their home by borrowing against the mortgage to remodel and increase the value of their home.

This same advisor also recommended avoiding term life insurance and suggested  to my friends to get whole life insurance--which they promptly did.  My friends felt so strongly about how whole life insurance is going to allow them to retire, I even got  the hard sell of how I am an idiot not getting whole insurance--even though I have the stash to replace life insurance.

I think life insurance is something as a topic in itself actually.

Am I missing something here?  I think I over study the problem and I would hope if I went to a financial advisor, they would steer me right but this is all contrary to not only my understanding, it's also contrary to my gut instinct.

[C40]

No. You're right. They're wrong. You're not missing anything.

Being capable AND willing to run the numbers, sadly, separates you from how the vast majority of people make critical financial decisions.

[arebelspy]

The crucial part is to run the numbers.

Paying interest SOLELY to save on taxes is not good.  But maybe it makes sense to pay interest to save on taxes if that's just one of the benefits that paying that interest will give you.

See, for example, MMM's recent article (a week or two ago) about using leverage, and example two where I had done some math on using leverage on rentals.  One of the benefits of having a mortgage on rentals is deducting your interest paid, but that's only one of about 5 reasons.  It shouldn't be a primary benefit, but nor should it be ignored.  Run the numbers.

[Rich M]

The crucial part is to run the numbers.

Paying interest SOLELY to save on taxes is not good.  But maybe it makes sense to pay interest to save on taxes if that's just one of the benefits that paying that interest will give you.

See, for example, MMM's recent article (a week or two ago) about using leverage, and example two where I had done some math on using leverage on rentals.  One of the benefits of having a mortgage on rentals is deducting your interest paid, but that's only one of about 5 reasons.  It shouldn't be a primary benefit, but nor should it be ignored.  Run the numbers.

I can definitely see a possibility of having a loan where it's a rental and maybe deduction expenses under a business.  These are cases where the people are doing this with their own homes.

What bugs me is that, at the time, financial advisors were pushing this stuff.  Either the advisors were ignorant or they had something to gain....me thinks they had something to gain.

[arebelspy]

Yes, financial advisers are - almost always - salesmen.

[gooki]

The main issue I see is it promotes lifestyle inflation.

But the general principal is sound. If your going to borrow money choose the option with the lowest interest rate, by which a tax deductible mortgage is likely to be the lowest total interest option available to general public.

[velocistar237]

Find the lowest cost living arrangement you can. If it's home ownership, then use the mortgage as leverage for reasonable investments. If you want more leverage, do it through rental properties, not a more expensive house. Don't spend money that you wouldn't have spent otherwise. It looks like your friends got most if not all of these important details wrong, and they'll be worse off in the long run.

[Mr Mark]

I can add my agreement to the previous comments. You've got it right. Your friends seem deluded about financial realities while being ripped off and living above their means on borrowed money.

Their argument is like saying because you bought a diamond encrusted $100k jet ski for 50% off that you've saved $50k...

And whole life is for mugs. Almost everything a 'FA' will try to get you to do is bad for you, good for everyone else in the industry, IF you understand a bit of finance etc. I guess if you're ignorant or unable to save at all, having a whole life is better than squandering your cash week to week.

But these guys will try to sell crap like 'variable annuities', whole life, high fee managed funds, long-term commitments with high upfront fees to them, and will also want you to use their services regularly and churn your portfolio.

[stashette]

I think you have to be very careful with financial advisers.  My first suggested I put my house down payment money in a mutual fund with a 5% load right after the Dow hit 14k.  Lost some money there, but at least they got that nice commission up front.

My second financial adviser came highly recommended from friends (like yours seems to be).  She suggested I buy a $1 million VUL policy on myself to use as a retirement savings vehicle.  I have no children and had no debts at the time.  I got out of that policy before I ever made my first payment though, so it was just a close call. 

Now I'm very skeptical of any FA and pretty much do my own thing.  The benefit of these experiences is that I have since taken the time to educate myself on basic personal finance, so maybe that money wasn't lost after all!

[Bank]

About ten years ago, I worked for a mutual fund and insurance company and I met many, many financial advisers.  Most of them care about nothing but the sale.  The vaunted employee training programs they attend are generally cheer leading sessions for favored products, and any monkey with half a brain can pass the FINRA Series 6, 63, and 7 exams that allow you to sell most retail investment products.

There are some advisors (generally older and FI) who have seen investment trends come and go and have survived.  They ignore company hype and focus on educating and holding the hands of their clients.  They are typically not geniuses, but if you don't have the talent, time or the inclination to manage your own money (very few like that on this board, I'd imagine, but such people do exist) they can be a good option.

One other note --- while I didn't work with the whole life products we sold, the general feeling within the company I worked was that they were a scam.  The products were fairly complicated, which allowed several layers of fees to be charged without much investor push back.  Needless to say, whole life was pretty popular among the advisers.

[Jason G.]

I generally think of interest deductions as an effective lowering of the stated interest rate. If my mortgage is at 4% and my marginal tax rate is 25%, then once I deduct the interest from my taxes my effective mortgage rate is really 3% (which is 75% of the original rate) with Uncle Sam making up the difference in lower taxes.

The deduction makes a difference, but it doesn't change anything fundamental.

[stigto]

It depends on your location and tax system. In my case (I live in Norway), it definitely pays to have a mortgage. I pay 3.6% interest on my mortgage, and even a high interest bank account pays 4%. I can also deduct 28% of the net interest payment. Also, there is a 1.1% asset tax on assets over approx. NOK 750.000 (about USD 125.000), but there is a 75% deduction on your primary residence. With rising property prises trading up is a net win with very little risk.