What is mortgage interest deduction?

Home buyers and home owners often think that they will benefit from mortgage interest deduction, but many times they don’t. How can you know for sure?

What is it?

When you borrow money to buy a home, you are charged interest. That interest is called mortgage interest and is potentially deductible on your tax return.

The amount of money that you can deduct depends on your tax bracket. See a list of tax brackets here.

Watch our video that explains exactly what you need to know.

Let’s say that you are in a 20% tax bracket and you pay $1,000 per month on your mortgage. If $800 of your mortgage payment is interest (and $200 is principal), then to calculate how much of a deduction you would get, you would multiply $800 times 20%, which gives you $160. $160 is the amount that you can deduct from your taxes, making a $1,000 mortgage payment only cost you $840 instead.

Your deduction is based on the annual mortgage interest and is taken at the end of the year, so you would add up each month’s interest payment from each mortgage payment for the 12 months of the year, multiply by your tax bracket percentage, and that is the amount that you might be able deduct from your taxes. Note that it is an end of tax year benefit, so you still have to make your full mortgage payment every month.

In what cases would you not get the benefit of mortgage interest deduction?

1. When you take the standard deduction instead of itemizing

If you take the standard deduction on your tax return (see a chart which shows standard deductions by tax bracket), then you will not benefit from the deduction.

If instead of the standard deduction you take itemized deductions on your tax return (which means that your actual expenses exceed the standard deduction) then the mortgage interest deduction is one of the actual expenses that helps lower your tax liability.

If you take the standard deduction, you will not benefit from any itemized deductions, including the mortgage interest deduction.

2. When your itemized deductions don’t fully exceed the standard deduction.

You could find yourself in a situation where you have enough deductions that itemizing makes sense but not enough to get the full benefit of the mortgage interest deduction. For example, if your expected deduction is $2,000, but adding up your itemized deductions, of which mortgage interest deduction is a part, only puts you $1,000 over the standard deduction, then you won’t realize the full benefit.

3. If you are in a high tax bracket

If you are in one of the top three tax brackets, there are other rules which may limit the number of deductions you can take. It’s best to talk to a tax professional to know for sure.

Does it apply to second homes?

Yes, you can deduct mortgage interest deduction on up to two homes.

Does it apply to home equity loans?

Yes, you can also deduct home equity loan and line of credit interest.

Is there a limit to how much mortgage interest you can deduct?

Yes, you can deduct up to $1,000,000 in mortgage interest and up to $100,000 in home equity loan interest per year.

Does this sound confusing? That’s because it is. Get our guide that walks you through how to tell if you can benefit from it.