How Adjustable Rate Mortgages Can Affect Your Taxes

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How Adjustable Rate Mortgages Can Affect Your Taxes

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Many people do their taxes as soon as they can collect the needed documentation. They do so hoping that they will be getting a refund, and the sooner they submit their form, the sooner they get their money. 

I, on the other hand, am in no hurry.  

The reason being is that I had to pay out last year, and I'm positive that my tax bill will be even higher this year. 

I know this because I failed to decrease my payroll withholdings after I made last year's April 15th payment to the government, and because I have an adjustable rate mortgage. 

Yes, I'm one of those people who utilized an adjustable rate mortgage to maximize the amount of house I could buy when my wife and I built our home seven years ago.  

I haven't converted to a fixed rate mortgage for the simple fact that the bank won't let me. When the bottom dropped out of the housing market, banks changed their policies such that you need to have a certain amount of equity in your home before they even think of letting you refinance. 

Since I do not have enough equity, I am stuck with my ARM. To be honest, it hasn't worked out too badly so far. For the first five years I was locked into a very low interest rate. In the two years that the rate has had the opportunity to adjust, my interest rate has actually decreased, causing my mortgage payment to go down. 

That sounds great, but what does my mortgage payment have to do with my taxes?

One of my biggest tax deductions is the interest I pay on my mortgage. The sum of all your deductions is subtracted from your income for the year to produce your adjusted gross income (AGI). 

The more deductions you have, the lower your AGI, and the lower your taxes owed to Uncle Sam. While getting a letter in the mail saying my mortgage payment is going down provides a little bump to the monthly budget, it also decreases the amount of interest I'm paying during the year on my mortgage. At tax time this meansHow Adjustable Rate Mortgages Can Affect Your Taxes? that my total deductions will be lower, my AGI will be higher, and the amount of taxes I owe will be more than last year, even if everything else stays exactly the same.

Compounding my tax time issue is the subject of property taxes. 

While we are constantly hearing that the economy is seeing signs of rebounding, home values continue to drop. My home was included in this tumble, therefore my property taxes were lowered accordingly. 

This had the positive effect of putting more money in my pocket each month, as I didn't need to put as much into escrow every month for that twice a year property tax payment. Of course, as with interest on your mortgage, property taxes are also a tax deduction. 

A decrease in property taxes causes an additional decrease in my deductions, another increase in my adjustable gross income, and another bump in my taxes owed.

I knew before 2010 even started that my property taxes were going down for the year. I knew well ahead of the April 15th tax deadline that I owed the government a check for the previous tax year. 

I got the letter in May indicating that my mortgage payment was going down. Therefore, I had several hints during the first half of the year that I should adjust my payroll withholdings so I could spread the pain of a higher overall tax bill throughout the year instead of being shocked by the size of that red number that my tax software is going to display when I finally do my taxes. 

It should have been easy, given that the decreased mortgage payment and the decrease in property taxes made more money available in the budget. 

If I wasn't going to change my withholdings, I should have at least started saving some of the money. 

Instead, I once again decided to take the short term gratification of the bump in my monthly budget.

It was this sort of faulty decision making that got me so deeply in debt to begin with.

Short term gratification vs. long term consequences.

Obviously I still have some work to do in the financial decision portion of my brain.

If you have an adjustable rate mortgage, or have had your property taxes reduced due to falling home prices, keep in mind that this will have tax time implications.  Do the smart thing and change your payroll withholdings as soon as possible, or, if you have the self discipline, start setting extra money aside immediately to handle a potentially higher tax bill.

Related Links:

 Choosing the Right Type of Mortgage

Mortgage Malaise vs Credit Card Crisis...What Should You Do?

 Time is Running Out

Travis PizelTravis Pizel 

Travis is a contributing writer for the My Journey out of Debt blog and is a very active member of the CareOne community forums. Travis is currently enrolled in a CareOne Debt Management Plan (DMP). Travis very candidly shares his personal journey to pay off his debt and the tips he's learned along the way. As a father and husband he provides a unique perspective on balancing debt, finances, and family.

Follow Travis on Twitter @DebtChronicles

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  • Hey Travis! It sounds like you've learned a lot from your experiences with the ARM and lowered property taxes. I know a lot of people may not realize that their allowable tax deductions would decrease with less mortgage interest and property taxes paid. I think your story will be helpful to many people.

    Hopefully you won't owe an enormous amount this year. Have you raised your payroll deductions yet so you won't have to deal with the same issue next year?

  • I definitely have learned my lesson.  I just wish I would stop learning these lessons the hard way. The stupid thing is that I knew it was going to happen....and yes, my new payroll deductions form has been submitted.   :)

  • I really suggest going to to learn how to take advantage of these low interest rates. It's focused on those who have ARM's and can't refi.

  • Thanks for the comment, Dave...I'll take a peek.

  • Hi Travis,

    Remember that your mortgage interest deduction is at most 35 cents on the dollar paid, maybe 25 or 15.  So even though you are paying higher taxes your cash flow position is better. For every 100 dollars you pay less on your mortgage you pay 35 more in taxes. For every 100 more in mortgage interest you pay 35 less in taxes. In the one case you gain 65 dollar and the other you lose 65.

  • Hi Chris, and thanks for taking the time to comment!   I agree with you 100% - the overall outcome is better.  The net is that I have more money....and that would have worked out great if I would have saved that 25 cents (or so) per dollar that my mortgage payment was decreased or adjusted my payroll deductions accordingly.  But I didn't....therefore I enjoyed the complete increase in cash flow for the whole year, and I'm now going to pay for difference in my tax bill in one lump sum.

  • As I continued answering the questions, and filling in numbers, the amount I owed was going down, but it soon became obvious that I when it was all said and done, I was going to owe more than I had been planning for.

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