Understanding mortgage interest tax deductions is an essential aspect of homeownership, as it can help you save money and maximize your tax benefits. Mortgage interest deductions can allow eligible homeowners to reduce their taxable income by deducting the interest paid on their home loans.
In this guide, we will provide you with an in-depth understanding of mortgage interest tax deductions, their benefits, and eligibility criteria, enabling you to make informed decisions about your mortgage and taxes.
What are mortgage interest deductions?
Mortgage interest is the cost of borrowing money to purchase or refinance a home. It represents the amount paid by the borrower to the lender for the use of the loan funds. Mortgage lenders will consider a wide variety of factors when determining the interest rate that you receive for your mortgage.
These include:
- Your credit score. Having a high credit score means that the lender is assuming less of a risk by granting your loan request, which can result in a lower overall interest rate.
- The location of the home. Some lenders offer different rates in different states, cities, and counties for a variety of reasons. These can include the health of the local economy, the local foreclosure rate, and local unemployment rates.
- The total amount of the loan. Larger loans can be more risky for lenders and may require a higher interest rate to offset some of the risk.
- The amount of your down payment. Paying off a large portion of the mortgage up front reduces the risk for the lender and can eliminate private mortgage insurance (PMI) requirements.
- The loan term. Shorter loan terms for the mortgage, such as a 15-year term, will typically feature lower interest rates than the traditional 30-year mortgage term.
- The type of interest. Adjustable-rate loans usually start lower than fixed-rate loans, but they could significantly increase during the loan term.
- The type of loan. Different mortgage loans (conventional, FHA, USDA, VA, etc.) can feature dramatically different interest rates.
The mortgage interest tax deduction is a federal income tax benefit that allows you to deduct the interest paid on a qualified home loan from your taxable income. This can reduce your overall tax liability and can result in significant savings. To claim the mortgage interest tax deduction, homeowners must meet specific requirements.
This means that you must:
- File your taxes using the itemized deduction method on Schedule A of IRS Form 1040.
- Have a secured debt (or debt that is backed by collateral) on a qualified home in which you have an ownership interest (or the rights of an owner).
- Ensure the mortgage is for a primary or secondary residence, not a rental property.
- Adhere to the deduction limits based on the loan amount and filing status.
What mortgages are eligible for deductions?
There’s no guarantee that you’ll be eligible for a home mortgage interest deduction, as not all mortgages are eligible. To qualify for a tax deduction, you must use the home you’re purchasing as collateral for the mortgage.
If you were to own a rental property and borrow against it to purchase a new home, then the interest payments on your new home likely wouldn’t be eligible for tax deductions.
You may be eligible for a tax deduction as long as your mortgage is classified as one of the following.
Home equity debt
Home equity loans are loans that you can take out against the value of your home in order to make improvements. For instance, if you currently own $100,000 in equity on your own, you could potentially take out a portion of that equity to renovate your kitchen, have some landscaping done, fix a leaky roof, or fence your yard.
The same criteria are also applied to home equity lines of credit (HELOC), which are commonly used as an alternative to home equity loans.
Refinanced mortgages
Refinanced mortgages can help homeowners take advantage of more favorable loan terms. For instance, if your current mortgage has a 5.9% interest rate, but the current average mortgage comes with a 4.9% interest rate, you can trade in your mortgage for a new one with this lower interest rate.
Plus, refinancing often gives you access to a lower principle that won’t collect as much interest. Many homeowners choose to refinance their mortgages depending on the current interest rate and market conditions.
This can also qualify you for mortgage interest deductions if the new loan meets specific requirements. The interest paid on the refinanced mortgage may be deductible up to the outstanding balance of the original mortgage at the time of refinancing.
Reverse mortgages are a common type of refinanced mortgage for people aged 62 and older, but the interest is typically not tax-deductible until the loan is paid in full.
Investment property mortgages
Mortgage interest on investment properties is typically deductible. However, it is subject to different rules and limitations compared to a primary or secondary residence.
The interest paid on an investment property mortgage can be deducted as a rental expense on Schedule E, reducing the taxable income from the rental property.
Are there limits on mortgage interest deductions?
The Internal Revenue Service (IRS) imposes limits on the mortgage loan amounts eligible for interest deductions. You can deduct interest on home acquisition debt up to $750,000 ($375,000 for married filing separately) for loans taken out after December 15, 2017. For loans taken before this date, the limit is $1 million ($500,000 for married filing separately).
The interest paid on home equity loans is deductible only if the loan proceeds are used to buy, build, or substantially improve the property securing the loan. Home equity debt used for other purposes, such as debt consolidation, credit card debt, or personal expenses, is not eligible for interest deductions.
The good news is that the mortgage interest tax deduction is not subject to phase-outs based on income. However, taxpayers with high incomes may face reduced overall itemized deductions due to the itemized deduction limitation that affects higher tax brackets.
You may also face tax deduction limitations depending on your filing status, as there are different limitations for married couples, heads of household, and single filers.
Fortunately, prepayment penalties and points paid on a mortgage may also be tax-deductible under certain circumstances. However, the rules for deducting these expenses are different from a regular mortgage interest.
How can you claim the mortgage interest tax deduction?
To claim the mortgage interest tax deduction, you must itemize your deductions using Schedule A of IRS Form 1040. This may involve additional record-keeping and documentation requirements compared with the requirements necessary for a standard deduction. For example, the amount of interest paid, the deduction amount, and the impact on your tax bill will need to be recorded.
You should receive a Form 1098 from your mortgage lender, which reports the total mortgage interest paid during the tax year. If you plan to claim the mortgage interest tax deduction, this form will be required. The additional records will need to be reflected in your federal and state tax returns.
When claiming your mortgage interest tax deduction, be aware of potential pitfalls and errors, such as:
- Confusing deductible interest and non-deductible interest
- Taking the standard deduction when it may be more beneficial to itemize deductions
- Incorrectly calculating the deductible mortgage interest amount
Mortgage interest tax deductions are complex, so you may want to consult a tax professional to ensure you are correctly claiming the deduction and maximizing your tax savings.
What are alternative tax strategies?
Mortgage credit certificates (MCCs) are tax credits for first-time homebuyers in specific state and local programs, allowing homebuyers to claim a percentage of their mortgage interest as a federal tax credit. This credit can be used alongside the mortgage interest tax deduction.
You may also be eligible to deduct their property taxes as part of your itemized deductions. This can provide additional tax savings in combination with the mortgage interest tax deduction.
If you use a portion of your home exclusively for business purposes, you may be eligible to claim the home office deduction. This allows you to deduct a portion of your mortgage interest, property taxes, and other home expenses related to your home office space.
Homeowners who make energy-efficient improvements to their homes may qualify for additional federal tax credits, reducing their tax liability.
How does the 2018 tax reform affect mortgage interest deductions?
The 2018 Tax Cuts and Jobs Act (TCJA) significantly increased the standard deduction, making itemizing deductions less beneficial for many taxpayers. As a result, fewer homeowners may be able to take advantage of the mortgage interest tax deduction.
The tax reform also introduced a $10,000 cap on the total amount of state and local taxes (SALT) that can be deducted. Unfortunately for homeowners, property taxes are included within the cap limit. This change may impact homeowners in high-tax states and further reduce the benefits of itemizing deductions.
Additionally, the tax reform limited the deductibility of home equity loan interest to loans used for buying, building, or substantially improving the property securing the loan. This change has made home equity loans less attractive for homeowners seeking tax advantages.
Frequently asked questions (FAQs) about mortgage interest tax deductions
Is mortgage interest tax deductible on second homes?
Yes, the mortgage interest on a second home is generally tax-deductible, but it is subject to the same loan amount limits and other restrictions as the mortgage interest applied to your primary residence.
Can I still deduct mortgage interest if I rent out my home?
If you rent out your home and use it as a personal residence for part of the year, you may still be eligible to deduct a portion of your mortgage interest, subject to certain rules and limitations.
Are mortgage points tax-deductible?
Mortgage points, also known as loan origination fees or discount points, may be tax-deductible if they meet specific IRS requirements. Points paid on home acquisition debt are generally deductible in the year they are paid, while points paid on home equity debt may be deductible over the life of the loan.
Can I deduct mortgage insurance premiums?
Mortgage insurance premiums (MIP) were tax-deductible for the tax years 2017–2020, but this deduction expired at the end of 2020. The Consolidated Appropriations Act of 2021 extended the deduction for the 2021 tax year, but as of the time of writing, MIP is generally not tax-deductible — though it is possible Congress could extend the deduction.
Review the current tax codes to maximize your deductions
Understanding the intricacies of mortgage interest tax deductions can help you save money on your taxes and make informed decisions about your home financing options. However, with the changes brought about by the 2018 tax reform, it's crucial to stay up-to-date on the latest tax laws and consider alternative tax-saving strategies.
One such strategy is using credit cards with rewards programs that help you save money on everyday expenses. Vital Card is a great example, offering cardholders cash back on their purchases, in addition to referral rewards and credit health rewards, which can then be applied toward additional mortgage payments.
With smart tax planning — and savvy financial strategies like using Vital Card — you can maximize your savings and may even be able to pay off your mortgages faster. Discover the benefits of Vital Card today.
Sources
Seven Factors That Determine Your Mortgage Interest Rate | Consumer Financial Protection Bureau
Publication 936 (2022), Home Mortgage Interest Deduction | Internal Revenue Service
Home Equity Loan vs. Home Equity Line of Credit (HELOC) | Equifax
Mortgage Tax Credit Certificate (MCC) | FDIC
About Schedule A (Form 1040), Itemized Deductions | Internal Revenue Service
How Did the Tax Cuts and Jobs Act Change Personal Taxes? | Tax Policy Center
Topic No. 504, Home Mortgage Points | Internal Revenue Service
Can I Deduct Mortgage Interest on My Taxes? | Experian
What Is Private Mortgage Insurance? | Experian
Vital Card blog posts are intended for informational purposes only and should not be considered financial or any other type of advice.