Project #2
The Mortgage Interest Deduction
Due September 16 at the beginning of class.
Introduction to the assignment.
When you borrow money for a house in which you will be living, the interest you pay on that
mortgage is tax deductible. For example, let us assume your income is $100,000 per year.
This gives you a marginal tax rate of 31%. You decided to purchase a $300,000 home and
you have no money for a down payment so you borrow the entire $300,000. The current
interest rate on mortgages is roughly 8%, therefore, the first year you pay 8% of $300,000 in
interest which is $24,000. Since this interest is tax deductible your taxable income falls by this
amount. Therefore, the amount of money you pay in taxes falls by the marginal tax rate time
$24,000, or $7,440. In summary, this $300,000 mortgage has reduced you taxes by over
$7,000 in the first year. The second year the principal on the loan is less, therefore the interest
you pay falls and the tax benefit is reduced.
The assignment.
Using your knowledge of mortgages, present value and spreadsheets you are to determine
how devastating the loss of the interest deduction on mortgages would be to the typical
household. To do this we want to find the present value of the tax savings due to the
deduction of mortgage interest.
The specifics:
Marginal tax rates: 15%, 28%, 31%, 36%, 39.6%
House values: $150,000 and $200,000 [Assume no down payment.]
Mortgage interest rate: 7.25% [Assume only one payment per year.]
Risk free market interest rate: 5.5% [Used in your calculation of the present value.]
You will need to turn in the following:
1. Find the present value of the deduction of mortgage interest for each of the five marginal tax rate and for homes costing $150,000 and $200,000. This will lead to ten different values.
2. In the written part of this assignment, explain your findings. Report the results of all 10 scenarios. Determine what types of households would receive the largest benefits from this
tax break? What types of households receive the smallest? A table might help.
3. Attach at least two of the spreadsheets used in this assignment. Make sure they are professional looking and easy to read and understand. For instance, a value in dollars should
be: $12,345.68 not 12345.67890123. Although you only have to print out two of these
spreadsheets, you must use your work to determine all 10 values. No group work is allowed.
4. Extra credit bonus. [5 pts.]
Determine how much lower interest rates would have to be for someone with a 30% marginal
tax rate to be indifferent between the lower interest and having the tax deduction and a
mortgage interest rate of 7.75%. We could think of this as the effective interest rate.