Can I Accelerate Interest Deductions?

August 5, 2002, Postscript September 21, 2002

"I need to shift as much expense as possible to 2002 because I intend to itemize that year. My thought is to pay in 2002 all 12 of my mortgage payments due in 2003, in this way shifting all the interest deductions from 2003 to 2002. I asked my banker and he said he did not see anything wrong with this. Do you?”

What’s wrong with it is that it won’t work. In fact, if you make all your payments for 2003 in 2002, it will reduce your interest expense in 2002, not increase it.

The interest due each month is calculated by multiplying 1/12 of the interest rate times the loan balance at the end of the preceding month. That amount goes to the lender as interest, and the remainder of the monthly payment is used to reduce your loan balance. If you add to your payments in 2002 the payments for 2003, the additional payments will be applied entirely to the balance, which will reduce your interest payments in 2002.

For example, your $200,000 30-year loan at 6.5% will have a monthly payment of $1264.14 and result in total interest payments the first year of $12934. If you push the payments for the second year into the first year by doubling each payment, total interest in the first year will be only $12474. Many people make extra payments precisely for the purpose of reducing interest payments.

There is no way to accelerate your interest payments, nor would you want to. An extra payment of $1264.14 that is used to reduce your loan balance goes from one of your pockets to another. Your cash and your debt are reduced by the same amount. If the $1264.14 instead went into the lender’s pocket as interest, your cash would be down by that amount and your benefit would be the tax saving, which is less than half as large. That’s a bad deal.

Postscript: It seems there is a way to advance interest payments, if the lender cooperates and the IRS allows it. (I am indebted to Michael Thaler for pointing this out to me.) The lender could simply apply advance payments immediately, as they would be applied in future months. It is illustrated below for a $100,000 balance at 6% with 300 months to go.

Date Paid Payment Due Interest Principal Balance
12/30/02 01/01/03 $500 $144.31 $99,855.69
12/30/02 02/01/03 499.28 145.03 99,710.66
12/30/02 03/01/03 498.56 145.76 99,564.91

Three payments are made on the last day of 2002, the payments are all applied immediately, the lender receives the interest from all three payments in 2002, and the borrower can deduct them in 2002 if the IRS allows it. Don't do it without checking with a tax attorney.

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