What’s The Mortgage Interest Deduction And Is It Right For You?

The single biggest tax advantage of homeownership is likely the mortgage interest deduction. In many cases, it can save you a lot of money on your tax bill. But whether it makes sense for you ultimately comes down to the math.

This is not meant to be tax advice. For individualized planning, consult a tax advisor.

Is Mortgage Interest Tax Deductible?

Mortgage interest is tax deductible if the mortgage qualifies. In order to qualify, the mortgage has to finance your primary home or a second home used for vacation. In addition, the mortgage purpose matters. The following mortgage debt qualifies for the deduction:

• Any mortgage taken out, on or before October 13, 1987, is eligible for the deduction regardless of its purpose.
• If taken out after October 13, 1987, your mortgage interest qualifies as tax deductible as long as it was used to buy, build or substantially improve your home.

It doesn’t matter whether the mortgage is a first or second mortgage as long as it’s used for the appropriate home purchase or improvement purpose. There are also limits on the deduction.

What Is A Mortgage Interest Deduction?

A mortgage interest deduction is the ability to subtract from your taxable income the amount you pay in mortgage interest and certain other qualifying fees each year. Like the majority of deductions outside the standard deduction, you have to itemize deductions in order to take advantage of this section of the tax code.

Standard Tax Deduction Vs. Itemized Tax Deduction

When you file your taxes each year, you can either take the standard deduction or itemize your deductions. In certain circumstances, itemizing your deductions can get you a bigger refund or lessen what your tax bill would otherwise be. One of the most common reasons to itemize is when you’ve paid enough mortgage interest that it makes sense to do so.

In order to determine whether you should take the standard deduction or itemize, you need to compare your itemized tax deductions with the standard deduction, which varies based on your filing status. The standard deduction categories for 2023 are as follows:

• Single or married filing separately: $13,850
• Heads of household: $20,800
• Married filing jointly or qualifying widow(er): $27,700

If the amount that can be taken off your taxes by itemizing is lower than the standard deduction, you should take the standard deduction.

As an example, let’s say you’re single. You have $9,000 in qualifying mortgage interest, $1,500 in deductible student loan interest and $500 in eligible charitable deductions. Because your itemized amount is only $11,000, you can save $2,850 more by just taking the standard deduction of $13,850.

Now, let’s hold all other factors constant but assume that you pay $12,000 in mortgage interest. Your new itemized total is $14,000. You can deduct $150 more from your income by itemizing rather than taking the standard deduction.

What Is The Home Mortgage Interest Deduction Limit?

The Tax Cuts and Jobs Act was signed into law on December 22, 2017. Although the intention of the law was to cut taxes for many Americans, it wasn’t a cut across the board.

As a result of the legislation, the limit on mortgage interest deductions has decreased. If you took out a mortgage prior to December 16, 2017, the mortgage interest deduction limit is $1 million ($500,000 if married filing separately). For the purposes of this deduction, the dollar figure refers to the loan amount rather than the amount of interest paid.

Now that the limit has been lowered for homeowners who purchased or refinanced homes on or after that date, 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 on or 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, build or improve a home – utilizing either a primary or second mortgage – 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).

• Limited purchase agreement exception: If you had a purchase agreement in place for your primary residence before December 15, 2017, with a closing date before January 1, 2018, you’re included under the prior $1 million ($500,000 if married filing separately) limits as long as the mortgage closed before April 1, 2018.

Types Of Home Mortgage Interest Deductions

There are several instances in which the mortgage interest deduction applies. Unless otherwise specified, we’ll be talking about the deductibility of interest on a home you’re purchasing. Refinancing and home equity loans are treated separately and quite a bit can depend on how you’re using the funds.

Mortgage Interest On Your Primary Residence

Money used to buy or build a primary residence qualifies for the mortgage interest deduction. This is the main home you live in throughout the year.

Mortgage Interest On Your Second Home

You can also deduct the mortgage interest when you buy a second home. It’s important to note that you can only take the mortgage interest deduction on one vacation home. However, there are certain instances in which you can change the property you take the deduction on during the year if you have more than one vacation home. Consult a tax preparer.

If you rent out your home at any point during the year, you have to use it as your home for more than 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental price, whichever is longer. If you don’t rent out your vacation home, there’s no residency requirement to qualify for the deduction.

Mortgage Interest From A Refinance

If you refinance your mortgage, the portion that’s based on your remaining principal on the loan from when you purchased your home is always considered deductible mortgage interest. Similarly grandfathered debt still has no limits as long as you don’t refi for more than the principal. It’s more complex if you’re taking on additional debt as in a cash-out refinance.

The additional debt taken on would only be considered deductible if it was used to improve the home in some way, such as through bathroom or kitchen renovations. Things get more complicated if you refinance your mortgage for multiple purposes such as remodeling and debt consolidation. In that case, we recommend speaking to a tax professional.

Interest on monthly payments and mortgage points aside, there are several mortgage refinance tax deductions that you may be able to take.

Interest On Qualifying Home Equity Loans

Interest on home equity loans is deductible to the extent that you use the loan to buy, build or substantially improve your home. You can’t deduct the interest if use the loan to invest, consolidate debt or buy a car, for example.

Interest On Mortgage Points

Mortgage points are prepaid interest purchased at closing in order to get a lower interest rate for the term of the loan. They’re as deductible as any other mortgage interest. The only difference is that you usually can’t deduct the full amount you pay in the year you pay it. While there are exceptions, the amount paid for points is typically deducted equally over the life of the loan.

As an example, let’s assume you paid $3,000 for points on a 30-year loan. You would deduct $100 per year on your taxes for the term of the loan. For additional guidance on when you would take the full deduction in a single tax year, consult a tax professional.

Penalties And Fees From Late Payments

Some lenders charge prepayment penalties if you pay off your loan prior to the end of a specified period defined in your mortgage documentation. If you have such a charge, this is generally considered deductible mortgage interest. The same is usually true of late payment charges.

Home Acquired During The Year

In cases where you acquire the home during the year, the general rule is that you can start deducting mortgage interest on your closing date. The same is true if you take on mortgage debt after picking up a home in a divorce. There are exceptions to the date rule, so feel free to speak to a tax advisor.

How To Receive A Mortgage Interest Deduction

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 servicer. This form 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 Circumstances That Make Claiming A Mortgage Interest Deduction Harder?

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

Mortgage Interest Calculation Example

Calculating your mortgage interest deduction is something you can do yourself. Divide the maximum debt limit by your remaining mortgage balance, then multiply that result by the interest paid to figure out your deduction.

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

Many people prefer to work with tax accountants in cases like these, just to make sure their calculations are accurate and there are no issues with the IRS.

What Homeowner’s Expenses Aren’t Tax Deductible?

Your mortgage interest isn’t the only deductible homeownership expense, but there are several common costs that do not qualify as a tax deduction:

• Homeowners insurance
• Hazard insurance
• Title insurance
• Closing costs other than mortgage points and prepaid real estate taxes
• Utilities
• Forfeited deposits, down payments or earnest money
• Internet or Wi-Fi service
• Homeowners or condominium association fees or common charges
• Home repairs

Exceptions And Special Circumstances

There are several special circumstances affecting whether you can or cannot deduct the mortgage interest associated with a property. Here’s a brief list:

• Rental properties: If you rent out part of your home, you can deduct the mortgage interest only if the following conditions apply: the tenant is living there, the portion of the home being rented doesn’t have self-contained sleeping, cooking and toilet facilities, and you don’t rent different parts of your home to more than two tenants and their dependents. If you have a separate rental property from your primary home, it doesn’t qualify for the mortgage interest deduction.

• Timeshares: A timeshare can count as a qualified second home for the purposes of the mortgage interest deduction. If you rent out the property, you have to follow the rules for rented vacation homes mentioned earlier. You count the days you’re using the property and the days you’re renting it only during the time that you have rights to the property.

• Co-ops: Under the right circumstances, those who live in co-ops can deduct the mortgage interest for their share in the co-op as long as their stock gives them the right to live in a house, apartment or house trailer owned by the co-op. There are other requirements regarding how land is used and income is derived. If you’re unsure, speak to a tax advisor.

• Divided use of your home: Let’s say you only use part of your home as a residence. Only the part used as living space can have the interest deducted on your personal taxes. You may have other deductions you can take on business taxes related to your professional use of your home.

• Home under construction: If you have a home under construction, you can treat it as a qualified home for up to 24 months, provided that you continue to have it be your qualified home after it’s ready for occupancy.

• Destroyed homes: If your home has been destroyed, you can continue to use it as a qualified home as long as you rebuild the home or sell the land where it was located within a reasonable period of time after the event.

• Ground rents: In some states, it’s common to not own the land on which a house is located but instead have it be subject to ground rent. If the ground rent is redeemable, you can include this as deductible mortgage interest. You can’t do this if it’s nonredeemable.

• Home sale: If you sell your home, mortgage interest is deductible up to, but not including, the sale date.

If you have any questions, a certified tax preparer should be able to help you apply the rules to your individual situation.

FAQs On The Mortgage Interest Tax Deduction

Now that we’ve touched on all the basics, let’s take a second to answer a few more questions.

Is reverse mortgage interest tax deductible?

When you have a reverse mortgage, you don’t have a mortgage payment. Rather, interest accrues on your existing home equity and nothing is due until you sell the home, move out or pass away. Because it’s considered interest on home equity debt, it’s generally not considered tax-deductible.

What are other common tax deductions for homeowners?

In addition to the mortgage interest, the other big tax deduction for homeowners is usually the property tax deduction. It should be noted that this falls under the category of state and local taxes for which the total limit on deductions is $10,000 ($5,000 if married filing separately).

What forms will I need to deduct mortgage interest?

If you paid at least $600 in mortgage interest in the prior year, your lender will provide both you and the IRS with a copy of your Mortgage Interest Statement, Form 1098. From there, you can calculate your deductible mortgage interest based upon the limits we discussed above.

The Bottom Line

Mortgage interest is deductible for both primary residences and vacation homes, subject to certain limits. To take advantage of this, you have to itemize deductions. Depending on the math, it can make sense for some to take the standard deduction instead.

You can also deduct interest when refinancing or taking a home equity loan if it’s being used to build, buy or improve your home. Additionally, you can take a deduction for the cost of mortgage points, prepayment penalties and late fees.

If you’re not sure about your situation, you should consult a professional tax advisor before making any judgments regarding your taxes. If you’re looking to purchase or refinance a home, you can get started today!