Q. Before we were married, my husband purchased a two-bedroom home in Houston in the late ‘80s.  We married in 1993 and finished paying off the house by 1998. The house was built in the ‘30s and is showing its age (it has been for some time).  I think we should sell the home and invest the money in a new house.  I think the tax breaks we would receive would help offset some of the mortgage.  Wouldn’t the tax breaks be still better if we rented the house out and bought another?

My husband's argument is that it is better to own a house outright (and pay property taxes in cash every year) than to pay into a mortgage because a mortgage is a debt.
---R.P. by email from Houston, TX

A. Sorry, but tax deductions won’t overcome the fact that more expensive houses are, well, more expensive. They cost more to support.  Some readers will think this is too obvious to merit discussion, but you are not alone in your wishful thinking. Millions of people desperately want to believe that if they borrow enough money, their house will be virtually “free.”

 Alas, it doesn’t work that way. Let’s walk through an example.

Recently, the median resale price of houses in the Houston area was $147,200. You didn’t provide a value for your house, but let’s assume it is worth $125,000 and you net $117,500 from the sale because you have to pay a 6 percent Realtor commission. Now you move to a $200,000 house, reserving $7,500 for closing costs and moving expenses. You take out a $90,000 mortgage at 6 percent to complete the transaction.

What happens? 

First, your operating expenses will increase. Figure about $175 a month. You’ll also have a mortgage that costs about $540 a month. So your shelter costs will rise by about $715 a month. That’s a large increase from what you are now paying.  

Sadly, tax deductions don’t come to the rescue. With estimated real estate taxes of $4,600 a year and mortgage interest of $5,400 a year, your itemized deductions from shelter are only $10,000 a year. That’s short of the $10,700 standard deduction for a couple. The only way to get a tax break is to borrow a lot more money or have other deductions such as charitable contributions. Even if you had deductions that brought tax savings, it would reduce only a portion of the increased spending.  

Does that mean you shouldn’t do it?   

No. It means you and your husband need to have a long talk about your priorities. You need to discuss what having a house you buy together means to you versus what having low shelter expenses means to him.

What about renting the old house and buying a new one? Sorry, that won’t do much for you either. First, you’ll be renting an old property in need of repairs and replacements--- so you probably won’t net much after expenses. And since the house was purchased in the late ‘80s, when prices in Houston were miserably depressed, you won’t have much
depreciation to cut the taxes on the rental income.

You’d also have two houses to take care of and the chance of the tenant who trashes your property and fails to pay the rent. Unless you have lots of extra cash reserves, owning one rental house is a pretty good formula for a financial mess. One of the common causes of personal bankruptcy in the Texas real estate crash of the ‘80s was the expense burden of owning a single rental house and a personal house. When the market turned them upside down--- owing more money than the houses could be sold for--- thousands of young homeowner/investors were driven into bankruptcy.

Finally, the expenses of your new house will be much higher because you’ll need to borrow all the money instead of only $90,000. Basically, you’re in a “can’t get there from here” position--- unless you and your husband, together, decide you want to spend more money on shelter.