I know this may sound sacrilegious, but the housing loan (mortgage) interest deduction is the most over-rated tax strategy in existence. I constantly hear happy “homeowners“ boasting about how much money they “saved“ with their mortgage interest deduction. Asking your boss to reduce your salary would perhaps have the same effect.

If you are in the 30% tax bracket each Rupee you pay interest on is only going to save you 30 paise. That means you are still spending 70 paise to save 30 paise. My family believes that I choose to become a CA over IIT because I am weak in mathematics. Even to my dumb head, this sounds like bad mathematics, correct?

This is actually the classic difference between a deduction and an expense write-off. Can you convince a businessman that an expense is good, just because it can be claimed as deduction? I doubt it.

The other question that I ask in all my classes “Is a car an asset?“  Thanks to `Rich Dad Poor Dad`; many people having read that, say no. Then I ask them “Is a house an asset?“ In spite of reading “Rich Dad Poor Dad“, people are still confused.

And you`re so happy with this so-called tax break you aren`t thinking clearly about what is really happening. In the first few years of a mortgage the majority of your payment goes toward paying your interest on the loan, not the principal. And homeowners think that`s fine; it means a bigger tax deduction. But if you can bring some logic to this you would realize you`re not building up any equity because of your payments.

You may be building up equity yes, but that is because real estate prices are going up.

The question has to be asked, what happens if they ever start to go down. But let`s just look at why the mortgage companies really have you pay the majority of the interest up front.

First, the stats show that homeowners tend to buy a second house in six or seven years. So that means when you go to sell you`ve only paid interest on your mortgage; you haven`t really paid down any of your principal which means that the lender has been getting interest on almost all of the money they originally lent you which in the long run helps them make more money but at your expense. At this stage the nice middle class homeowner go back to the lender, pay off the loan and take a fresh loan, and the interest payment cycle continues.

Thank God for my shareholding in India`s biggest mortgage company! They surely got their maths correct, and so did I!

Let me come to my favorite topic of compound interest. Why do people feel happy about real estate?

I think it is simple mental heuristics. People do not understand the importance of the compounding formula (Future value = present value * (1+ r) ^ n).

That is why they come up with “My father bought a house in Santa Cruz (an up market suburb of Mumbai) for Rs 30,000, now it is worth Rs 30,00,000. We see it as a great 100 bagger! Great.“

However if you see that the purchase was made in the year 1964 and do an IRR it comes to “only“ 11% p.a. If you factor in the interest cost, maintenance, and society charges, it does not sound too great, does it? This was over a period when inflation was hovering between 9 and 19% in India, and when for many years cost of funds was in excess of 12%.

Also this person was earning a princely sum of Rs 900 in 1964 – which meant he was paying 33 times his monthly salary for a house. However at a CTC of Rs 18L p.a. I am paying only 20 month`s salary. Thus the house, expressed in terms of inflation adjusted return may not be worth it.

Now while I know most people need a mortgage in order to purchase a home, there will come a time in your life when it will make sense to get rid of your mortgage. So I don`t want you to just keep paying a mortgage under the guise that it is your only tax write-off.

Very few seriously rich people have a mortgage. They simply write a cheque. Its simple guys, “its better to receive interest rather than pay interest“.

Did you know that only since the Second World War the mass psychology changed from “use value“ to “ownership value“. Earlier, people like my Grand dad (decision circa 1919) was happy to rent 2 houses in Central Mumbai location and pay a rent for the rest of his life. One more thing I cannot understand is how come we treat different assets differently?

Do you think you and your husband will do a 2nd job to support a Porshce, or a Mercedes? Sounds irrational, correct?

Do you say “Invested in a car?“ Well, I have not heard that ever. How come you cannot invest in steel but can invest in steel and cement?

It beats me, but thankfully the home loan interest deduction is gone after all!! (direct tax code!)

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  1. Subra Sir,

    1 question-
    Assuming i am in 30% tax bracket, home loan rate will be 7% for me (10% before tax).
    So, if I can manage greater than 7% in alternate opportunities, isn’t it better to buy house on loan rather than putting 100% equity ??

  2. Subra,

    I agree with you on “House as an investment – A big no no!”

    But, I would surely buy a house for me to use as a Home. Forget financials, a house you own will give you stability & peace of mind as it fulfills the basic necessity of life.

    Lets assume someone is going through a stock market crash (or) a bank with all his deposit going down in the later part of their life. As far as he has a house and some gold to sell, he can at least eat food and sleep in his house. What if he had invested everything in stock market (or bank deposits) and rented a house? Well, you now have a new beggar family in the streets!

    You can argue that by chance the house may destroyed by an earth quack. But compare the chances of earth quack with the chances of financial instability of a country and you’ll see a 1:100 ratio 🙂

  3. Mr Prabhu..If anyone is investing to save oneself when the whole market will crash believe me it is not guarantee that person will live peacefully.

    If you are so much afraid and so much prepared for worst then just accumulate gold.

    The point Subra is making is about investing in home but you are talking about mind of piece both opinions are very different.

    If investment decisions will be based on worst assumptions and forecasting no body will invest single penny in market.We should understand our liabilities and risk profile after that we need to invest in any instrument.

    Mr Subra it is very subjective matter to buy a house or not but the point you have mentioned here in support of “Do not buy home just to save the Tax” is excellent.

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