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Mortgage Interest Deduction: What You Need To Know

4-Minute Read
Published on August 12, 2021

The decision to buy a home can be a stressful one, especially if you’re a first-time home buyer. There are a ton of responsibilities involved when it comes to purchasing your first home, but homeownership also comes with many benefits. The major benefit when you buy a home is that you have security. You can get a fixed-rate loan and know that, unlike rent, your monthly payments will never increase. You can build equity in your home as you pay off your mortgage, and take comfort in the fact that your property will appreciate if you hold onto it long enough.

One immediate perk of getting a mortgage to buy a house is the mortgage interest deduction. By reading this article, you’ll learn what a mortgage deduction is, how much you can subtract from your taxable income and what you’ll need to take advantage of this great tax incentive.

What Is A Mortgage Interest Tax Deduction?

The mortgage interest deduction is an itemized tax deduction that subtracts interest paid on any loan used to build, purchase or renovate a residence from taxable income. This means that for your primary home – or even any secondary homes you can deduct a certain amount of mortgage interest every year and pay less income tax.

Who Qualifies For A Mortgage Interest Deduction?

In order to benefit from a mortgage interest deduction, your mortgage, home equity loan or HELOC must have been used to purchase, build or improve your primary or secondary home, and the property must have been used as collateral for the loan. However, you can also claim a mortgage interest deduction if you refinanced your home.

However, to qualify, you must itemize your deductions. Therefore, it’s only worthwhile if, after adding your mortgage interest, your itemized deductions are greater than the standard deductible.

The standard deductions for 2021:

  • Single: $12,550
  • Married filing jointly: $25,100
  • Married filing separately: $12,550

If your total deductions are below the standard, you should refrain from itemizing and just take the standard deduction instead.

Mortgage Interest Deduction Calculator

When it comes to calculating your mortgage interest deduction, you can easily do so in the comfort of your home. You’ll need to divide the maximum debt limit by your remaining mortgage balance, then multiply that result by the interest paid to figure out your deduction. Many people revert to financial experts in cases like these, just to make sure their calculations are accurate and there are zero issues with the IRS. 

Let’s consider an example: Your mortgage is $1 million, and since the deduction limit is $725,000, you’ll divide $750,000 by $1 million to get 0.75. You’ll pay $60,000 in interest for the year, and that multiplied by 0.75 will show that you can ultimately deduct $45,000.

Can I Deduct My Homeowners Insurance And PMI? 

Unfortunately, you can’t deduct your homeowners insurance but you are able to deduct private mortgage insurance. Although you can deduct the interest you pay on a primary and secondary residence, a home equity loan, prepaid mortgage points and prepayment penalties, not all of the payments you make qualify as mortgage interest. In fact, most of your home expenses can’t be deducted. Here’s a list of other common home payments that aren’t tax-deductible:

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Your Mortgage Interest Deduction Limit

Since the Tax Cuts and Jobs Act took effect, the limit on mortgage interest deductions has decreased. Prior to 2018, the mortgage interest deduction limit was $1 million. Now that the limit has been lowered, taxpayers who are single or married and filing jointly may only deduct up to $750,000 of interest. For married couples who file separately, the limit is now $375,000 each. However, there are certain exceptions to these new rules:

  • Grandfathered debt. If you took out a mortgage before October 13, 1987, you can deduct all of the interest that you pay. There is no limit because you’ve been grandfathered in.
  • Home acquisition debt. If you took out a mortgage to purchase a home after October 13, 1987 but before December 16, 2017, you can deduct up to $1 million (or $500,000 if you’re married and filing separately).
  • Home equity debt. If you took out a second mortgage after October 13, 1987 but before December 16, 2017, for any reason other than to build or improve your home (e.g., consolidate debt, add to a college fund, etc.), you can deduct interest on mortgage amounts up to $100,000 (or $50,000 if you’re married and filing separately). 

Mortgage Interest Deduction For Prepaid Interest Points

There are also special rules regarding when you can apply your deduction for prepaid interest points. You may be able to deduct more of your points in the year you bought them. But, generally speaking, you can’t deduct the full cost of prepaid points in the year you paid them. Instead, you can deduct a portion of the points each year over the life of the loan.

To determine the amount you can deduct each year, use the following equation:

(Prepaid points / Full term of loan in months) x Number of mortgage payments made each year

As an example, let’s say you bought a house with a 30-year mortgage term and paid $3,400 in points upfront. Here are the steps you would need to complete:

1. Multiple the full term of the loan by 12 to determine what the loan term is in months:

30 x 12 = 360

2. Divide the cost of the points paid by the full term of the loan (in months):

$3,400 ÷ 360 = $9.44

3. Multiply the result by the number of mortgage payments made in the tax year:

$9.44 x 12 = $113.33 deduction each year.

How To Receive A Mortgage Interest Deduction

In order to receive a mortgage interest deduction, you need to ensure that you obtain and fill out all of the appropriate forms. At the beginning of the year, you should receive a Form 1098 from your mortgage lender. The 1098 will state exactly how much you paid in interest and mortgage points over the course of the year, and act as proof that you’re entitled to receive a mortgage interest deduction. Be aware that you will only receive this form if you have paid at least $600 in interest during the tax year.

To qualify, you will also need to itemize your deductions and report them on Schedule A, Form 1040. This form will have you list all of your deductions, including donations to charity, medical expenses and the information about your mortgage interest found on your 1098.

Are There Any Mortgage Interest Deduction Circumstances?

There are certain circumstances that can make claiming a deduction more difficult or require more forms. Some of these outliers include living in a co-op building, renting out part of your residence and being under construction.

The new stipulations for mortgage interest deductions can be incredibly confusing, which is why we recommend speaking with an expert. A professional will walk you through your options and ensure that you are able to deduct as much of your taxable income as possible.

The Bottom Line: Utilize Your Mortgage Tax Deduction

When it comes to mortgage interest deduction, there are many questions to be asked, especially as a first-time homeowner. Although at first glance it can seem overwhelming, being able to utilize a mortgage tax deduction can be very beneficial. We encourage you to take the opportunity to speak with a financial planner or tax professional for any further questions related to mortgage interest deduction.

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Call our Home Loans Experts at (800) 251-9080 to begin your mortgage application, or apply online to review your loan options.

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