I recently read this blog post on Forbes called “4 Financial Myths Than Can Hurt You.” Sounds interesting doesn’t it? Who doesn’t want to bust some myths that could be hurting you financially? The problem is that in trying to dispel these myths, the author perpetuates some of his own. Let’s take a look at each “myth.”
Myth #1: You should string out your mortgage to maximize the interest deduction.
The author has a point here. You don’t want to let the tax tail wag the dog. (Taken to its extreme, the most effective way to minimize taxes would be to not have any income at all.) He’s right that prepaying the mortgage would save you more in interest than you would lose in tax deductions. (Also keep in mind that itemized deductions like mortgage interest only reduce your taxes to the extent that they exceed your standard deduction.)
But there are other factors to consider. If you don’t have an emergency fund, that should take priority. Otherwise, you might not be able to make even your regular mortgage payment if you lose your job. You should also pay off higher interest debt like credit cards first.
The author also leaves out the opportunity cost of what you could do with that money instead. For example, let’s say that your mortgage rate is 4% and you’re in the 25% tax bracket. After taxes, that mortgage interest might be costing you 3%. Unless you’re keeping almost all your money in cash or bonds, there’s a pretty good chance you could earn more in the long run by investing extra money than you would save in interest by prepaying your mortgage. This is especially true if you haven’t maxed out tax-advantaged accounts like a 401(k) or IRA. That’s why there’s even a case for never paying your mortgage off at all.
Bottom Line: Yes, don’t string out your mortgage to maximize the interest deduction. But don’t necessarily prepay it either. Instead, consider stringing out your mortgage to make your dollars go further somewhere else.
Myth #2: You should always minimize your tax withholding.
The author argues that tax withholding can be a good savings strategy since interest rates on savings accounts are so low anyway. There are several problems with this argument though. First, that money might have gone to pay down high-interest debt, which could save quite a bit of money. Second, he forgets that one of the reasons to save is to have money in an emergency. Well, it’s kind of hard to do that when the IRS has your emergency money and won’t give it back to you until after you file your taxes next year. Third, if you don’t need the money for emergencies, you can get the same convenience of having the money deducted from your paycheck while getting more bang for your buck by instead contributing it to your employer’s retirement plan. Once you get your refund, it will be too late to do that and you would miss all the extra earnings your money could have earned throughout the year.
Bottom Line: Loaning your hard-earned money to Uncle Sam for free is still a bad idea in my book. Just don’t go too far with it or you could end up owing penalties to the IRS for having too little withheld. You can use this calculator to determine your proper withholding and then make sure you put those extra dollars to good use.
Myth #3: Deferring taxes saves you money.
The author claims that deferring taxes in a retirement account all evens out in the end after you pay taxes on the withdrawal unless your tax rate changes. For that reason, he says that young people may be better off paying the taxes upfront if they expect to be in a higher tax bracket in retirement. But even if you pay the same rate when you retire (which is doubtful when you consider that a lot of your retirement account withdrawals are likely to be taxed in the lower brackets even if your marginal tax bracket is the same in retirement), you’re still better off because the money that would have gone to taxes each year can instead stay invested and produce extra earnings. His point about young people may be true when it comes to a Roth account, which can grow tax-free, but otherwise I doubt that people’s tax rates will be so much higher in retirement as to make them worse off by deferring the taxes.
Bottom Line: Unless you’re temporarily in a very low tax bracket, you’re almost certainly better off deferring taxes whenever possible. The exception is if you have a Roth option. In that case, check out this and this.
Myth #4: It’s easy to minimize credit card costs with 0% offers.
I would agree if he was referring to the difficulty of qualifying for 0% balance transfer offers, especially for people with lots of credit card debt and low credit scores. Instead, he says that opening and closing credit card accounts can hurt your credit score and that you may have to pay balance transfer charges. First, opening a credit card account can actually help your score by decreasing your utilization. Second, who said anything about closing cards? You can always transfer the balance and then simply cut up the old card without closing the account. As for the balance transfer charge, a 3-4% fee seems pretty low relative to the double digit interest rate you would otherwise be paying.
He is right about one thing though. The focus should be on actually paying down the balance rather than just transferring it. I just think lowering the interest rate, even temporarily, wouldn’t hurt either. In fact, I’ve taken advantage of zero percent balance transfer offers myself quite a bit over the years and actually made money from them.
Bottom Line: The less you can pay in interest on your debt, the better. Just don’t forget that the best way to minimize that interest in the long run is to pay it off.
There really are financial myths out there that can hurt people though. Have you heard about other “myths” that you’re not sure about? Leave them in the comments below and we’ll see if they deserve to be upheld or busted.