Deductible v. non-deductible debt

August 30, 2007 6:55 PM

At what point is it not worth making student-loan debt into mortgage debt?

My accountant has advised my wife and I to pay off her sizable student loans by rolling them into our home debt. Because of our income, her student loan interest is not tax deductible, but the home loan interest would be. But she has a very low interest rate on some of this debt. Is there a calculator somewhere that can show me that he is correct (or incorrect)? I sometimes get the feeling he is so philosophically opposed to paying taxes he would simply rather pay more to a bank than less to the government. When I ask him specifically at what point it would not be worth it, he simply assures me we are not in that boat.

posted by anonymous to work & money (9 comments total)

Ask your accountant to show you the math that he did in order to reach his conclusion. If he hasn't done the math or can't show you in black and white why his advice is good advice, you need a new accountant.
posted by The World Famous at 7:06 PM on August 30, 2007

To help you with this in an effective way, we need to know your current tax rate, the student loan rate and your mortgage rate. It would be great if you could follow up with that.

You should also consider how long you were planning to take to pay off your wife's student loans. If you were on track to pay them in 10 years but rolling them into your mortgage means you'll take 20 years, you may actually pay more by including them in your mortgage. For example, at net 5% interest over 10 years, you would pay roughly $14k in interest on a $50k loan. At net 4% over 20 years, you'd pay $28k in interest, even though your rate is lower. But all this really depends on the loan amount, years left on mortgage, and your tax rate.

Moreover, many people do not actually pay off their mortgages in 20 years. They end up moving again and refinancing for another term to afford a bigger home or what-have-you. So you might find yourself paying this loan off over 40 years if you put it in your mortgage. However, YMMV.
posted by acoutu at 7:26 PM on August 30, 2007

I'd also like to point out that you would be converting a non-secured debt into a debt secured by the thing you live in. They can't repossess her education, but they sure can repossess your house. Since taking an additional home loan would up your payments, if anything bad were to happen (loss of job, etc.), the house would disappear faster than if you hadn't. Think about that if the difference is small monetarily.
posted by cschneid at 7:29 PM on August 30, 2007

Something that may (or may not) be a consideration is that many types of student loans are forgiven upon the death of the debtor, while this is not the case for your mortgage. So this move may mean you should increase your life insurance coverage.
posted by winston at 7:32 PM on August 30, 2007

I think this is a bad idea however you look at it. If you can, look into student loan consolidation instead. If you pay by direct deposit and pay every month, after 4 years Sallie Mae will take off interest points from your loan. I have a couple of loans at 2.5% interest now. I don't think you get better than that.
posted by Deathalicious at 7:37 PM on August 30, 2007

As noted, some more info is needed to figure this out. But maybe you can do the math along the following lines:

Let's assume her interest rate is 4% on the student loans, and you could roll this into a mortgage by refinancing now at 6.5%. Let's assume also that your marginal Federal tax rate is 28%. (Have a look here to look up your actual rate.) Let's assume also, you're in a state with a 5% income tax rate, so in total, your marginal rate is 33%.

So, that 6.5% mortgage interest, being deductible, is subsidized by Uncle Sam and your governor to the tune of 33%, which reduces it to 4.355% on an after tax basis. That would mean, you're better off keeping the student loan intact, since it's 4% after tax. (As well as before tax.)

Even if the numbers were slightly different and the mortgage option came out slightly better, as acoutu has explained, rolling it into a mortgage is likely to stretch out the payment period and cost you more over the long run.

In general, your strategy should be to put the highest priority on paying your highest-interest loans (figured after tax), first. So, don't hurry to pay that student loan, which is probably your lowest-interest debt. Put any extra money first toward credit card debt, then car loans, then mortgage, then student loans.
posted by beagle at 7:38 PM on August 30, 2007

Another thing to consider is that bankruptcy does not discharge student loans anymore; you have those around your neck forever. It's not really unsecured debt these days.
posted by Malor at 7:59 PM on August 30, 2007

Two other factors to consider:

1. There is a cap on how much of your home equity line attributable to expenses other than home improvement or acquisition can qualify for the interest deduction. I think it's $100k for married couples filing jointly. So if you already have substantial home equity debt or the amount of the loan balance exceeds $100k, you won't be able to deduct all the interest.

2. If you are covered by the Alternative Minimum Tax, I believe you can only deduct the interest attributable to amounts you used to pay for home improvement or acquisition expenses. You wouldn't be able to deduct the student loan payoff to the extent you are paying AMT.

Your accountant should (hopefully) be able to address these issues and those raised above.
posted by brain_drain at 8:29 PM on August 30, 2007

I wouldn't do it. There are intangibles here that your accountant isn't considering. They all have to do with unforeseen catastrophes that still nonetheless do happen to people from time to time - if you don't believe it, check your loan agreements, they have language covering them.

They've mostly all been mentioned - her death, the temporary or permanent loss of your ability to repay your home mortgage, etc. Because these things can happen, the usual recommendation is never convert unsecured debt into secured debt. I agree with this wholeheartedly.

Besides that, student loan interest rates are so heavily subsidized that even without the tax break you're still often beating inflation by just holding the paper. In that case, don't screw around - just make the minimum payment and let time do the work of devaluing your debt for you. If you can hold it long enough eventually that $100K of school debt will be fully repayable by the price of a loaf of bread.
posted by ikkyu2 at 9:38 PM on August 30, 2007