Filing taxes is never what most rational folks would call “fun,” but if you own a home, the onerous process may at least lead to a nice bit of delayed gratification down the road. Because if you have a mortgage, you could be looking forward to a federal tax break in the form of a mortgage interest deduction. So what exactly is a this deduction?
In a nutshell, the mortgage interest deduction allows you to subtract whatever you’re paying toward mortgage interest from your taxable income. And the lower your taxable income, the less you pay in taxes! Sweet!
The mortgage interest deduction has been in place since the original tax code, and while many politicians and officials over the years have broached the idea of eliminating it, it remains in place—at least for now—most likely because it serves as a solid incentive for people to buy rather than rent, says Shayna Chapman, a certified public accountant at Shaynaco LLC in Gallipolis, OH. After all, putting down roots is good for communities and our nation at large, so it makes sense that Uncle Sam would want to reward homeowners with a tax break.
Here’s how mortgage interest deductions work, and how much they can save you come tax time.
How to deduct your mortgage interest
Homeowners who want to take advantage of this tax deduction must itemize their deductions (on Form 1040) rather than take the standard deduction—currently $6,300 for singles and $12,600 for married couples. As such, in order to benefit, you’ll want to make sure your total deductions fall over that limit. With a mortgage, that’s typically easy to do.
“A mortgage interest deduction is single-handedly the biggest thing that throws taxpayers over the line in order to be able to itemize,” says Chapman.
This is particularly true in the early days of a mortgage, because this is when the lion’s share of a mortgage payment goes toward interest (those added fees charged by your lender) rather than the principal (where you whittle down the actual balance on your mortgage).
Let’s take, for instance, a married couple in the 28% tax bracket (that means a joint annual income between $151,201 and $230,450) who bought a home with a $300,000, 30-year mortgage at an interest rate of 4%. In their first year of living there, these homeowners will pay $11,904 in mortgage interest. Combined with other itemized federal deductions such as property taxes, home improvements, or private mortgage insurance, this easily puts them in the zone where it makes sense to itemize their deductions and reap the tax rewards.
All told, these homeowners can expect to save $3,333 in taxes during their first year in the home. However, by the loan’s 30th year, in 2046, their interest payments will dwindle to $367, and their tax savings to $103. Still, though, this family should be happy, because by the end of their loan, they’ll save $60,370 on their taxes in total.
But then again, it’s naive to presume that mortgage interest deductions are a boon to all homeowners. In fact, data suggest that only about 54% of taxpayers who pay interest on mortgages will receive a tax benefit—and even those who do may not find the savings as huge as they might have hoped.
It all depends on your specific circumstances. For instance, if you are near the end of your mortgage or don’t have many itemized deductions, your mortgage interest may not be a windfall at all. Speak to an accountant and/or enter your numbers into a tax savings calculator to get a sense of what makes financial sense for you.
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