Is Mortgage Interest Tax Deductible?

Everything You Need to Be Considering

For homeowners, a mortgage is an unfortunate fact of life. Whether you got a great deal on a property or not, the debt you take on still negatively impacts your financial situation. However, there are some upsides to shouldering a mortgage – primarily when it comes to your taxes. In some cases, any interest that you pay on your mortgage is tax deductible if you correctly itemize it on a tax return. Of course, this isn’t true for every situation, and the amount you could potentially save on your income taxes varies. Let’s explore how you can maximize this tax deduction, whether it applies to your situation, and some common misconceptions about the process.

What exactly is a mortgage interest rate?

Simply put, a mortgage rate is the rate of interest charged on your mortgage. The interest is usually decided by your individual lender. It can be fixed, variable, and it typically fluctuates based on a baseline interest rate. Mortgage interest rates vary across lenders, locations, and your personal financial situation that’s qualifying you for the mortgage.

And you can deduct that interest rate on your taxes?

In some cases, yes. However, the benefits of this tax deduction are often overblown. Per a study performed in 2005, only 54% of taxpayers who are currently paying interest on their personal mortgage receive a benefit on their taxes. And many of the individuals receiving a benefit on their taxes are likely receiving less than they were “sold” on by their lender.

As with any tax deduction, you must determine whether or not you’re eligible in the first place. It is not true that every person who owns a home and has a mortgage automatically receives a tax break as a result. You’ll first have to determine whether you are eligible (there are guidelines as to who can deduct their mortgage interest rates, as well as how much is deductible based on your situation). It’s also important to recognize that, in all likelihood, you will not be able to deduct as much as you pay. There isn’t a one-to-one rate for what you’re paying in interest versus what you’ll be able to directly deduct on your tax return.

Why is there so much misinformation about mortgage interest tax deductions?

The first misconception that we’ve already briefly addressed is that all homeowners are eligible to deduct their mortgage interest rate on their taxes. This isn’t true. It largely depends on your personal filing situation, the total cost of your loan, and what you’re spending on your interest rate. The second miscommunication is that you’ll be able to get a one-to-one return based on what you pay in mortgage interest. This is also untrue. Instead, the official mortgage interest deduction looks at your income in the form of “tax owed” based on your tax bracket.

The misinformation surrounding the mortgage interest rate tax deduction boils down to two factors:

  1. Mortgage lenders are trying to sell you on purchasing a home, and therefore on paying them more than your loan in interest.
  2. Home buyers and owners haven’t educated themselves on the mortgage interest deduction – and therefore they aren’t aware that they aren’t being credited for the full amount they’re paying in mortgage interest. Instead, they’re reduced to tax brackets and there are standard deductions based on your tax bracket and the interest you are paying.

What steps can I take to deduct my mortgage interest on my taxes?

You’re first going to need to ensure that you’re itemizing your tax deductions. This simplifies your taxes, which is a benefit. It also makes it easier to break out specific deductions – such as your mortgage interest. The next step is to research your tax bracket, and the corresponding benefits you’ll receive. In general, the lower your tax bracket, the lower the benefit.

Finally, from a comprehensive financial planning perspective, you should do the math. Is the amount that you’re currently paying in interest worth the ultimate tax benefit you receive each year? Or would your wealth growth be better served if you paid down the debt faster – avoiding interest altogether – and used your “extra” money to invest or build a savings. Every situation is going to be unique – you must find the right answer for you.

Although there are some fairly common misconceptions about the mortgage interest deduction for itemized taxes, it does benefit many people. Granted, these benefits may be small, but it’s worth looking into. In any situation where you are a homeowner, make sure that you are knowledgeable about how this deduction could positively (or negatively) impact your taxes and your overall financial wellbeing. Who knows – you may be missing out on a deduction that could save you thousands each and every year!

Finding a reasonable monthly return

When calculating your future mortgage payments, many people tend to think very optimistically. That’s how foreclosures went up 81% in 2008 – people are not really thinking through what kind of payments they would be able to make in the worst case scenario. When something like being laid off work happens, people either lose the property they worked so hard to achieve in a heartbeat or they are in a position where they cannot even hold on the other basic expenses (we’re not talking home warranties but things like obligatory home insurance, basic food products, or education).

Think very well ahead of taking any mortgage so you won’t find yourself in worse position in a matter of years!