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The Mortgage Interest Deduction: Limits and Qualification

tl;dr

What You Need To Know

  • A mortgage interest deduction lowers what you owe in taxes by deducting your mortgage interest from your annual income
  • You can only qualify for mortgage interest deductions if your mortgage is a secured loan and you itemize your deductions
  • In addition to mortgage interest, you can deduct interest from a home equity loan, mortgage points and other types of home equity debt

Contents

If you’re like most homeowners, you’re probably looking for ways to get the most value out of your home. Fortunately, there’s a way to do that come April 15 (hint: the tax filing deadline). You can do it by using the mortgage interest deduction.

Essentially, you alert the IRS to all the money you paid in interest on your home, and in exchange, you get to use that same amount to lower your tax bill. 

Read on to see if you qualify and what the limits are for the mortgage interest deduction. 

What Is the Mortgage Interest Deduction?

The mortgage interest deduction is a tax deduction that lowers your taxable income (aka the amount of money you earned in a tax year) by subtracting the interest you’ve paid on your mortgage, as well as other qualifying expenses we’ll get into later. 

To qualify, the debt has to be from a secured mortgage. That means that the home acts as the collateral for the mortgage.

And you can only deduct your mortgage interest if you itemize your income tax deduction. To itemize, use Schedule A to list all of your allowed expenses.

What Are the Limits and How Much Can You Deduct? 

The short answer is that it depends on when you bought your home.

Before the Tax Cuts and Jobs Act of 2017, you could deduct interest on the first $1 million of your mortgage debt.[1] This was good for a lot of homeowners because the interest they paid was usually higher than the standard deduction (we’ll get into that in a minute).

The act changed the equation. It doubled the standard deduction and lowered the amount of mortgage debt you could claim to $750,000. It also added new restrictions that based the mortgage interest deduction on how you used the money.

So, if you bought your home before December 15, 2017, you could still claim the deduction for up to $1 million. After that, you were limited to $750,000.[1]

Standard Deduction vs. Itemized: Does Using the Mortgage Interest Deduction Make Sense for You? 

The first question many of us tackle when filing our taxes is whether we’ll take the standard deduction or an itemized deduction.

In other words, you want to figure out if all of your deductible expenses add up to more than the standard deduction.

To start, here are the standard deduction amounts for the 2021 tax year[2]:

  • $12,550 (single taxpayers and married, filing separately) 
  • $18,800 (heads of households, couples or families with one income only) 
  • $25,100 (married couples, filing jointly)

When to take the standard deduction

Let’s assume that you’re single and bought a $300,000 home at 3% interest with a 30-year fixed-rate mortgage. 

Your monthly mortgage payment will be $1,264.81. Because your payment is a combination of principal and interest, $514 will go toward the principal and the remaining $750 will go toward interest.  

Each month after that, a little bit more of your payment will go from paying your interest to paying your principal.

Assuming that you made your first payment in January, after a year, you will have paid $8,914.34 in interest.

If your only deduction is your mortgage interest, you’re better off taking the standard deduction. You’ll get more back and you (or your tax preparer) will save time because you’ll be using a simpler form.

When to itemize deductions

Now, let’s say you bought that same $300,000 house at 6% interest with a 30-year fixed-rate mortgage. After that first year, you will have paid $17,899.78 in interest, and that’s definitely more than the standard deduction ($5,349.78 more, to be exact!).

Here’s another scenario: Let’s say that in addition to your mortgage interest you have other expenses you can deduct, including:

  • Charitable deductions (up to 100% of your gross income)[3]
  • Property taxes (up to $10,000)
  • Self-employed health care insurance premiums

If your allowable expenses and your mortgage interest total up to more than the standard deduction, you’ll probably want to itemize.

What Qualifies for the Mortgage Interest Deduction?

The cool thing about the mortgage interest deduction is that you can deduct a wide range of secured home loans and other expenses related to buying your home.[4] This includes:

The mortgage for your primary residence

For most of us, this is our only mortgage. But you can deduct the interest for all kinds of homes, including a single-family home, co-op, condo, mobile home, house trailer or houseboat. As long as the home has a place to sleep, something to cook on and a toilet – and you’re paying a mortgage on it – it counts.

The mortgage for a second home or timeshare

If you own a second home or vacation home (or part of a vacation home) you can deduct the mortgage interest. 

A word of warning: You can rent out the home for part of the year, but to qualify for the deduction, you need to have lived there for at least 14 days or more than 10% of the number of days during the year that the home is rented at a fair rental value, whichever is longer.

Otherwise, the IRS will consider the home an investment property, and it won’t qualify for the tax deduction.

Also, if you have more than one second/vacation home – yes, that’s a thing – you can only treat one home as the qualified second home during any year. The good news is that you can choose which second/vacation home to claim a deduction on. 

So, if you’re paying more in interest on one home compared to another, you may want to consider selecting the home that offers the highest possible deduction.

A home equity loan (aka a second mortgage) or home equity line of credit (HELOC)

Because you’re borrowing against your home, home equity loans and home equity line of credit (HELOC) loans also count toward the mortgage interest deduction. 

There’s one thing to note here. Before the 2017 Tax Cuts and Jobs Act, no matter what you used the loan for, you could deduct the interest. Today, you can only take the deduction if you’re using the money to buy, build or improve your primary or second home. 

Mortgage discount points

When you get a mortgage, you can opt to buy mortgage discount points. Each point costs about 1% of your home loan and lowers your interest rate by 0.25%.

If you bought mortgage discount point(s), you can deduct what you paid for the point(s). You would either claim the total amount you paid the year you bought the home or deduct that amount over the life of the loan.

Prepayment penalties

If you pay off your mortgage early and your lender charges you a prepayment fee, you can deduct it as mortgage interest. (FYI: Not all lenders charge this prepayment fee.)

Mortgage insurance

If you’re paying for mortgage insurance and your adjusted gross income (AGI) is less than $100,000 (this applies whether you’re single or married and filing jointly), it can also count toward the mortgage interest deduction. 

That applies to private mortgage insurance (PMI), mortgage insurance premiums (MIPs) on Federal Housing Administration (FHA) loans, funding fees on Veterans Affairs (VA) loans or guarantee fees on U.S. Department of Agriculture (USDA) loans.

What Doesn’t Qualify for the Mortgage Interest Deduction?

Of course, not all home buying expenses qualify for the home mortgage interest deduction. For example:

  • Insurance that doesn’t relate directly to the mortgage, like homeowners insurance and title insurance, can’t be deducted.
  • Making extra payments toward your mortgage principal can help you pay down your mortgage faster, but you can’t deduct extra payments on the principal.
  • If you just became a homeowner, you probably had to pay closing costs, a down payment and an earnest money deposit. As you’ve probably guessed, none of these costs are deductible.
  • Wraparound mortgages (where the seller finances the loan) don’t qualify for the deduction.

How Do You Claim the Mortgage Interest Deduction on Your Taxes?

Let’s say that you decide to itemize your deductions and take advantage of the mortgage interest tax deduction. First, you’ll need to know how much you paid in mortgage interest over the previous tax year (January — December). 

Form 1098 

Assuming your mortgage interest was more than $600, your lender or loan servicer should send you a Form 1098 that reports how much you paid in mortgage interest. 

The form is usually sent around January or February. If the April 15 tax deadline is fast approaching and you still don’t have the form, see if you can download it from your lender’s or servicer’s website or give them a call.

If neither of these options works or you paid less than $600, check your December mortgage statement and see if it shows interest paid year-to-date. If it does, you can use the statement to fill out the Form 1098 worksheet to help calculate your mortgage interest.

Schedule A

While most tax returns start with Form 1040, if you’re itemizing deductions, you’ll need to fill out a Schedule A as well. You’ll list all of your allowable deductions there, including medical and dental expenses, charitable contributions and property taxes. 

Enter your mortgage interest deduction on line 8 of the Schedule A form.

Taking Advantage of the Mortgage Interest Deduction

While the mortgage interest deduction may not save homeowners as much as it once did (compared to the standard deduction), if you’ve paid a lot in mortgage interest, you should take advantage of the deduction to lower your tax bill.

The key to taking advantage of the deduction is to know what you can deduct and to have all your paperwork ready when you talk to your tax preparer or file your return.

Don’t be afraid to ask questions. When it comes to paying less in taxes, every penny helps.

  1. Internal Revenue Service. “Interest on Home Equity Loans Often Still Deductible Under New Law.” Retrieved October 2021 from https://www.irs.gov/newsroom/interest-on-home-equity-loans-often-still-deductible-under-new-law

  2. Internal Revenue Service. “IRS provides tax inflation adjustments for tax year 2021.” Retrieved October 2021 from https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2021

  3. Internal Revenue Service. “Charitable Contribution Deductions.” Retrieved October 2021 from
    https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions

  4. Internal Revenue Service. “Publication 936, Home Mortgage Interest Deduction.” Retrieved October 2021 from https://www.irs.gov/publications/p936

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In Case You Missed It

Take-aways

  1. The limits on how much mortgage interest you can deduct were significantly changed with the 2017 Tax Cuts and Jobs Act
  2. If your mortgage interest is less than the standard deduction, it may make more sense to file using the standard deduction rather than itemizing deductions
  3. Your mortgage lender or loan servicer should provide you with a Form 1098 at the end of the tax year

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