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What is a Mortgage Interest Deduction?

By Arvin Sahakian · Nov 30, 2014 · Mortgage

What is a Mortgage Interest Deduction?

Image courtesy of StockMonkeys, StockMonkeys

The I.R.S. rules for mortgage interest deductions can significantly reduce your personal income taxes. Learn how to take advantage of this benefit.

Believe it or not, there was a time when people did not pay income taxes. The 16th Amendment to the Constitution and the Revenue Act of 1913 changed that, and are the reasons why we pay income taxes today.

As both a taxpayer and homeowner you have the added advantage of being able to reduce your taxable income by deducting the mortgage interest you pay on your mortgage via the rules set forth in I.R.S. Publication 936.

What is Mortgage Interest?

Mortgage interest is that portion of your mortgage payments which go towards the interest cost of your home loan. Principal payments are not deductible.

Where to Find Your Total Mortgage Interest?

The easiest way to find out what you pay for the interest portion of your home loan is by taking a look at Form 1098 which your lender is required to send to you each year. Most lenders send you this form at the beginning of the year before income taxes are due.

If you can't wait, you can also check your December mortgage statement which will show you the total interest you're paying for that month and the total year-to-date total interest already paid.

And if you can't wait until December, check out this amortization schedule. Just provide your loan amount and interest rate to get an estimate of your total interest payments for the year.

How Does Mortgage Interest Deduction Work?

A tax deduction is the amount you can reduce from your income, which decreases your taxable income and in turn reduces the amount of taxes you are required to pay. When you borrow a loan to buy, build, or remodel your home, the mortgage interest deduction will reduce your taxable income by the amount of interest you have paid.

Example of mortgage interest deduction:

  • You paid $25,000 in principal and interest payments for your mortgage in a given year.
  • Of those payments, $15,000 was for interest.
  • Your taxable income will be reduced by $15,000.

BeSmartee TipTip: A tax deduction reduces your taxable income. It is not the same as a tax credit which reduces your total taxes on a dollar for dollar basis. In the example above, at a typical income tax bracket of 28%, your tax bill will be reduced by about $4,200!

Mortgage Interest Deduction Rules

The I.R.S. has in place rules which govern how you may qualify for and use the mortgage interest deduction benefit. We'll cover the most common rules. You can read more details directly from the I.R.S. here.

You Must Itemize Your Deductions

The interest you pay on your mortgage is deductible only if you itemize your deductions instead of using the standard deduction when filing your income taxes.

Your Home Must Be Owner Occupied

The mortgage from which you are using to deduct your interest must be for a primary or second home only. Additional homes will not qualify for mortgage interest deductions.

Take note that your second home cannot be a rental or income property and must be occupied by the owner at least part-time.

You Must Be On Title of Your Property

You are not required to be a signer on the mortgage loan, but you must be on the title of your property.

This is a common scenario when parents who have better credit than their children help by signing for a mortgage loan. The child may be making all the payments, but if the child is not on title he/she will not be able to claim the mortgage interest deduction benefit.

Your Home Must Actually Be a Home As Defined by the I.R.S.

To take advantage of the mortgage interest deduction, the interest you pay must be secured by a home as defined by the I.R.S., otherwise it's considered a personal loan which is not tax deductible.

A home is any property that has sleeping, cooking and toilet facilities, such as:

  • Single Family House/Townhome
  • Condominium
  • Cooperative
  • Mobile Home
  • Boat
  • Recreational Vehicle

Common Types of Loans Available For a Home

  • Mortgage to buy or refinance
  • Second mortgage
  • Line of credit
  • Home equity loan
  • Construction loan

What Else is Tax Deductible from Your Mortgage?

Don't forget to include other expenses which can add to your tax deduction benefits. These include, but are not limited to:

  • Lender fees paid to attain your loan, such as points and origination fees. Check your HUD-1 Statement from your loan documents.
  • Property taxes
  • Mortgage Insurance (MI). Not all loans have MI, so check with your lender to see if yours does.

Mortgage Expenses That Are NOT Tax Deductible

Not all your expenses as a homeowner are tax deductible. The following are common costs many homeowners incur which are unfortunately not tax deductible:

  • Homeowners insurance
  • Fire insurance
  • Flood insurance
  • Title insurance
  • HOA payments
  • Credit report fees
  • Appraisal fee
  • Escrow fees

What If More Than One Person Owns the Home?

If you own your home with another person whom you do not file taxes jointly with, you can only deduct mortgage interest pro-rata to what you actually paid. Be sure to coordinate with your other owner so there is no confusion or errors which may cause you to either claim too little or too much.

Key Takeaways

The IRS tax rules for mortgage interest deduction was created to help promote homeownership. As a homeowner you have a unique opportunity not available to other taxpayers to significantly reduce your personal income tax liabilities:

  1. Total mortgage interest actually paid can reduce your taxable income and total personal tax burden.
  2. You can also deduct other mortgage costs such as lender fees, property taxes and mortgage insurance.
  3. There are specific requirements to qualify, such as being on title to your property and that your home must be owner occupied.
  4. Be sure to check with your tax specialist to confirm your ability to benefit from the mortgage interest deduction.

Note: BeSmartee provides the information herein for educational purposes only. This is not tax advice. Be sure to check with your tax specialist.

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