Thanks to tax law changes, paying down conventional mortgages may be smart

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Aloha Capital originated 15 loans for the Fund in April. All loans are collateralized by single & multi-family residential real estate and personal guarantees from sophisticated real estate investors. Since inception of the Fund, Aloha has now originated over 550 loans!

Aloha Capital originated 15 loans for the Fund in April. All loans are collateralized by single & multi-family residential real estate and personal guarantees from sophisticated real estate investors. Since inception of the Fund, Aloha has now originated over 550 loans! 

Americans held nearly $15 trillion in total conventional mortgage-related debt as of the end of 2017. That averages out to about $178,000 of debt for everyone with a mortgage, according to Nerdwallet. That’s a lot of debt, and a lot of mortgage interest. 

Some people don’t mind debt, others aren’t fans. So if one doesn’t like it, why not pay it down? Seems worth considering, but in the past if you propose paying off your mortgage to your tax adviser, you’d likely hear: “What? And lose your tax benefit!” But thanks to the new tax law going into effect in 2018, the math regarding mortgage debt has changed. That’s because millions of Americans won’t be able to deduct their monthly mortgage-interest payments. With the deduction now gone, paying down the mortgage may be the smart thing to do.

For 2017, 32 million tax filers got a mortgage-interest deduction. For 2018, that number will drop to 14 million, according to the Wall Street Journal. Americans’ total savings from this break is expected to drop this year from nearly $60 billion for 2017 to $25 billion for 2018, according to Congress’s Joint Committee on Taxation.


This is the result of changes to the longstanding ability of filers to deduct home-mortgage interest on Schedule A. The new tax law took away personal exemptions but compensated by roughly doubling the size of the standard deduction. In 2018, the standard deduction will be $24,000 for married couples filing jointly, $18,000 for heads of household and $12,000 for single individuals. Meanwhile, the allowable itemized deduction for state and local taxes, including property taxes, will be capped at $10,000 starting next year. 
For those claiming the standard deduction in 2018 (most people), it may make sense to pay down the mortgage. Here’s an example to explain why: Let’s say you have a $300,000 mortgage with a 4% interest rate. With mortgage interest fully deductible in recent years, if you were in the 28% tax bracket, your after-tax effective interest rate was only about 2.9% on that mortgage (.04 * (1 – 0.28)). But without the deduction, the effective interest rate on the mortgage is now the full 4%.

Thanks to the new tax law, your after-tax mortgage rate just went up by 38%. The difference between 4% and 2.9% is real money — especially on a large mortgage. In the above example, removing the interest deduction makes the mortgage about $3,300 more expensive per year.

If you have funds invested in stocks or bonds, markets with deteriorating risk-reward profiles, paying off the 4% mortgage early is suddenly looking like a decent — risk free — investment. One reason for not paying down the mortgage, if you have the money to do so, is that you may need the cash to live on for emergencies or other contingencies. Once you pay off the mortgage, getting access to it again would require a home equity loan.


Also keep in mind that banks, brokerage firms and financial advisers typically will not advise you to pay off your mortgage. Why? Because they want you to keep the money invested with them! But if you have enough liquid assets to feel comfortable, you can effectively earn a risk-free and tax-free return by paying your mortgage down. Before doing so though, you’ll want to consult with your tax adviser who is no doubt up-to-speed on the new math of mortgage debt. It will be interesting to see what effect this has on the US housing markets.

The tax law changes, as put forth before, were relegated to a much smaller percentage of homeowners than the final version. And since we’ve written on this subject in a prior letter, we wanted to revisit it with this update. In our view, the basic supply and demand fundamentals that have propelled real estate markets higher for many years do remain in place.

This is particularly true in the rental and turnkey markets, but is the case in other market segments as well. We’ll continue keeping tabs on stats that provide insights on local and regional markets, and will be happy to share them with you here. Aloha Fund produced another nicely positive month in April, and May looks good, too.

The Fund is actively seeking new capital, so please reach out with your questions and referrals. 


We greatly appreciate your patronage and trust.

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