How the mortgage interest deduction helps homeowners

What is the mortgage interest deduction?

Buying a home is a
proven method of wealth-building; you’ll
build equity as you pay off your loan and the home grows in value.

there’s another financial benefit for prospective homebuyers. Come tax time
each year, you might qualify for the mortgage interest deduction.  

consult a tax professional before filing, but for some homeowners, the mortgage
interest tax deduction can reduce their taxable income by thousands of dollars.

tax law changes over the past few years have led to a decrease in the number of
Americans who claim the mortgage interest deduction.

you’re a current or aspiring homeowner, here’s what you should know.

Verify your home loan eligibility (Jan 10th, 2021)

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Who qualifies
for the mortgage interest deduction?

The Tax
Cuts and Jobs Act of 2017 changed the rules for the mortgage interest

2017, if you take the standard deduction, you cannot deduct mortgage

For the 2020
tax year, the standard
deduction is $24,800 for married couples
filing jointly and $12,400 for single people or married people filing

But if you use itemized deductions instead of claiming the standard deduction, you can deduct the interest you pay each tax year on mortgage debt. This includes any mortgage loan used to buy, build, or improve your home.

You may also be able to deduct interest on a home equity loan or line of credit (HELOC), as long as the loan was used for one of those three purposes.

Mortgage interest deduction limits

The amount of mortgage interest you can deduct depends on
the type of home loan you have and the way you file your taxes.

  • If you are single or married and
    filing jointly, and you’re itemizing your tax deductions, you can deduct
    the interest on mortgage debt up to $750,000
  • If you are married and filing
    separately from your spouse, you can deduct interest payments on mortgage debt
    up to $375,000 each tax year

mortgages taken out prior to 2018, the rules are a bit different.

  • For any home loan taken out on or before October 13, 1987, all mortgage interest is fully deductible
  • For home loan taken out after October 13, 1987, and before December 16, 2017, homeowners can deduct interest on mortgage debt up to $1 million (or $500,000 if married and filing separately)
  • The $1 million limit also applies to homeowners who entered a binding purchase agreement between December 16, 2017, and January 1, 2018

You can
deduct interest payments on home
equity loans and lines of credit, too, as long as the debts were
used to pay for home improvements or to purchase or build your home.

If you have a home equity loan or line of credit and the funds were NOT used to buy,
build, or substantially improve your home, then the interest cannot be

Other requirements to claim your deduction

with staying within the IRS’s limits, to qualify for the mortgage interest tax
deduction your home must:

  • Be listed as ‘collateral’ to
    secure the loan
    — Interest on a personal loan or
    credit card used for home improvements won’t go toward the tax deduction,
    because this debt isn’t secured by the property like home equity debt
  • Have basic accommodations — The home must have plumbing and other basic living
    requirements to qualify for the deduction
  • Be a part-time residence — Owners of second homes who also rent out their homes must
    live in the second home at least 14 days (or as much as 10% of the days the
    home is rented out if that number exceeds 14 days) to claim the deduction on
    Schedule A. Otherwise the interest must be reported on Schedule E as an
    investment property

How the mortgage interest tax deduction helps

off home acquisition debt tends to help homeowners with higher incomes. That’s
because high-earning homeowners typically have larger mortgage balances and are
more likely to buy a second home or vacation property– both of which increase
tax-deductible mortgage interest payments.

means their home mortgage interest is more likely to exceed the federal income
tax’s new, higher standard deduction of $24,800 for couples filing jointly or
$12,400 for individual tax filers.

Real estate agents and home builders still tout this tax deduction as an incentive to buy a home. They like to claim that it increases the homeownership rate and helps people transform from renters to homeowners.

thanks to the new standard deductions created by the 2017 Tax Act, a larger
share of homeowners will not itemize their taxes and thus won’t be able to
deduct mortgage interest.

What other costs are tax-deductible?

interest isn’t the only cost of homeownership that’s tax-deductible. If you
choose to take itemized deductions, you could also deduct:

  • Mortgage points
    Homebuyers often pay cash upfront to lower their mortgage rate for the life of
    the loan. For example, paying an extra 1% of the loan amount can lower the
    interest rate by 0.25%. Cash paid for mortgage points can qualify for the
    interest deduction
  • Prepayment penalties — Most
    new mortgages don’t charge prepayment penalties, but older loans may still require
    them. If so, you could write off the prepayment penalty as part of your
    mortgage interest tax deduction
  • Late payment fees — Even late
    payment fees qualify for the mortgage interest tax deduction
  • PMI — Congress has extended the rule
    allowing homeowners to deduct mortgage insurance payments. This applies to
    loans with private mortgage insurance (PMI) as well as government-subsidized
    mortgage insurance on FHA, VA, and USDA loans

Property taxes are also tax-deductible, but they are
not included in the mortgage interest deduction. They are written off elsewhere
on the 1040 Schedule A tax form.

So, what
does tax law exclude from the home mortgage interest deduction?

  • Homeowners insurance premiums — Homeowners insurance premiums are not tax-deductible. However, you may be able to write off this expense if you have a home office and deduct those expenses on Schedule C
  • Other home buying costs — Title searches, earnest money, moving expenses — none of these costs qualify for this tax deduction
  • Reverse mortgage interest — Since interest on these loans comes due when the property sells, they aren’t tax-deductible

you claim the mortgage interest deduction?

Remember, you can take the mortgage tax deduction only if
you itemize your taxes. And that’s only worth doing for taxpayers whose write-offs exceed the standard deduction.

example, say you and your spouse own a home with a $315,000 mortgage loan. Your
itemized deductions might look something like this:

  • Mortgage interest: $9,500
  • Property taxes: $3,000
  • Charitable donations: $2,000

total itemized deductions come out to $14,500. In this case, as a couple filing
jointly, you’d want to take the $24,800 standard deduction because it far
exceeds your itemized deductions.

But if you were a single homeowner with the same itemized deductions — or a married one filing separately — you’d want to itemize. That’s because the sum of your itemized deductions is greater than the standard deduction of $12,400. 

Consult a professional tax advisor

As with
any major decision, consult a professional when deciding how to file taxes. A
licensed tax advisor can review your situation and let you know how to deduct
mortgage interest – or if you should at all.

How to claim the home mortgage interest

To claim
the mortgage interest deduction, a taxpayer should use Schedule A which is part
of the standard IRS 1040 tax form.

Your mortgage
lender should send you an IRS 1098 tax form which reports the amount of
interest you paid during the tax year. Your loan servicer should also provide
this tax form online.

your 1098 tax form, find the amount of interest paid and enter this on Line 8
of Schedule A on your tax return. Seems pretty simple, right?

the deduction gets more complicated if you earn income from the property. If
you own rental properties or a vacation home you rent out most of the year, for
example, you’ll need to use Schedule E.

If you’re
self-employed and write off business expenses, you’ll need to enter interest
payments on Schedule C.

Should the
mortgage interest tax deduction affect your home buying decision?

Buying a
home requires a series of financial decisions.

have to choose a home and find the right loan type, but you’ll also decide how
much money to put down and whether to lower your interest rate with mortgage

decisions continue after closing on the loan: Should you pay off the mortgage
quickly by making higher monthly payments, or invest your extra money
elsewhere? Should you get a new loan to tap home equity, or find another way to
finance repairs and projects? 

All these
decisions could impact a homeowner’s ability to save money through the mortgage
interest tax deduction.

example, making a larger down payment reduces your loan balance, which lowers
interest payments that can be deducted.

buying mortgage points at closing lowers the interest rate of the new loan,
which also reduces tax-deductible interest paid to the lender.

And, of
course, paying off a mortgage entirely eliminates interest payments altogether,
which could bump some taxpayers into a higher tax bracket.

should you maintain higher mortgage payments for the purpose of lowering your
taxable income through the mortgage interest deduction?

Only you
and your tax professional can answer this question, because the answer depends on
your unique situation and your broader financial life.

unless you itemize deductions, you can’t claim the home mortgage interest
deduction anyway. In that case, the tax deduction should not affect your home
buying and mortgage paying decisions.

Verify your home buying eligibility (Jan 10th, 2021)

Politics behind the mortgage interest tax deduction

Congress passed the Tax Cuts and Jobs Act of 2017 (TCJA), the number of U.S.
households claiming the home mortgage interest deduction declined from about
22% in 2017 to below 10% in 2018, according to the IRS.

Fewer homeowners have written off their home mortgage interest after 2017 because the TCJA raised the standard deduction. This meant fewer Americans had an incentive to itemize their deductions with the IRS.

Also, the
TCJA lowered the cap on mortgage interest deductions from $1 million to
$750,000 for married couples filing jointly, and from $500,000 to $375,000 for
single filers.

In response to the TCJA’s changes, the Brookings Institution has called for Congress to eliminate the mortgage interest deduction altogether and replace it with a one-time tax credit of $10,000 for each new mortgage.

current tax deduction lowers a taxpayer’s federal taxable income which has the
potential to change a taxpayer’s tax bracket; a tax credit would lower the
amount of income taxes due regardless of income and could be claimed by more

has used tax credits as incentives for homebuyers before, most recently during
the housing crisis of 2009 and 2010. Some states still offer targeted tax
credits to encourage home buying in specific areas.

What are today’s mortgage rates?

Mortgage and
refinance rates repeatedly set new record lows in 2020.

With such
low rates, mortgage payments are more affordable than ever. Homebuyers have not
needed tax incentives to encourage buying or refinancing.

But if you do decide to use it, the mortgage interest deduction is a nice perk, and yet another way homeownership can bolster your personal finances.

Verify your new rate (Jan 10th, 2021)

The Mortgage Reports does
not provide tax, legal or accounting advice. This material has been prepared
for informational purposes only, and is not intended to provide, and should not
be relied on for, tax, legal or accounting advice. You should consult your own
tax, legal and accounting advisors before engaging in any transaction.