When you own a home, one of the more appealing tax benefits is the potential to write off mortgage interest. Mortgage interest can often make up a significant chunk of your monthly payment, especially when interest rates are high, or you are in the beginning years of paying on your mortgage. So, understanding how tax deductions work — and when it’s worth itemizing deductions — can put extra money back into your pocket at tax time.
What are tax deductions?
First, let’s discuss tax deductions and how they work. Tax deductions are expenses you can subtract from your total taxable income, reducing the amount of your income you are subject to tax. Common tax deductions include charitable donations, medical expenses, some business costs, and even mortgage interest.
Here’s a quick example: Let’s say you make $60k per year, and you make a monetary donation of $1,000 to your favorite charity. You could claim that donation as a deduction. This would mean that at the end of the year, you would only be taxed on $59,000 of income instead of $60,000.
There are many different ways of using tax deductions, but there are essentially two ways to claim deductions on your taxes. You can itemize your deductions, or you can take the standard deduction. A standard deduction is set by the IRS each year and is a flat amount that taxpayers can subtract from their income without needing to list specific expenses. This amount varies by filing status (single, married filing jointly, or married filing separately).
Conversely, you can choose to itemize your deductions and list out specific expenses. You would choose this option when your deductible expenses exceed the standard deduction amount to save more money.
The standard deduction nearly doubled because of the 2018 Tax Reduction Act. These numbers, as mentioned, do change from year to year as the government changes them to account for things like inflation and the economy. But here is a general snapshot of the standard deductions so you can get an idea of what your itemized deductions would need to be in order to make claiming those worth your time and effort.
What is the Mortgage Interest Deduction?
In this article, we will focus specifically on mortgage interest deductions. This tax break is for homeowners who pay interest on their mortgages. Part of what you pay on your monthly mortgage payment is interest. If you itemize deductions on your federal income tax return, you can deduct interest paid on your mortgage, reducing your taxable income. This deduction can make a significant difference, especially during the early years of a mortgage, when interest payments are at their highest.
How Mortgage Interest Write-Offs Work
- Qualifying Mortgages: The mortgage interest deduction is available for primary and secondary homes used as residences. The loan amount for deduction eligibility is up to $750,000 for married couples filing jointly or $375,000 for single filers (for mortgages originating after December 15, 2017). Mortgages issued before this date have a higher threshold of $1 million.
- Itemizing Deductions: Mortgage interest can only be deducted if you itemize deductions rather than taking the standard deduction. For 2023, the standard deduction is $13,850 for single filers and $27,700 for married couples filing jointly. Itemizing is often worth it when your total deductions (including mortgage interest, state taxes, charitable donations, etc.) exceed the standard deduction.
- Deduction Amount: Your mortgage lender will provide Form 1098 showing the amount of interest paid over the year. You can include this amount on Schedule A when itemizing deductions on your tax return.
Why High Mortgage Rates Make Itemizing More Attractive
With higher interest rates, a more significant portion of your monthly mortgage payment goes toward interest rather than principal repayment. Here’s how this can work in your favor:
- More Interest = Higher Deduction: When interest rates are high, the amount of interest you’re paying — especially during the first few years of the mortgage — can be substantial. This can significantly increase your itemized deduction total.
- Itemizing vs. Standard Deduction: With today’s high-interest environment, more people are finding that their mortgage interest alone can add up to a sum that justifies itemizing deductions. For example, if your annual mortgage interest is $15,000 and you also have other deductible expenses (like property taxes and charitable donations), the total could well exceed the standard deduction.
Calculating the Tax Benefit of the Mortgage Interest Deduction
Let’s consider an example. Let’s say you’re married and file jointly. You have a mortgage with $18,000 in annual interest payments, and your other deductible expenses include $5,000 in state income tax and $3,000 in property tax. In this case, your total itemized deductions would amount to $26,000.
- Standard Deduction Comparison: Since the standard deduction for married couples filing jointly is $27,700, your itemized deductions would need to exceed this to make itemizing worthwhile. If you expect to pay a high level of interest on your mortgage over several years, these deductions could make itemizing financially beneficial in the long run.
Additional Considerations for Maximizing Mortgage Deductions
- Look at the Big Picture: Consider your tax situation holistically, including any state tax benefits, if applicable. In some states, property tax and mortgage interest may have additional benefits that make itemizing even more attractive.
- Review Annually: Even if you itemize one year, it doesn’t mean you have to itemize every year. Review your expenses annually, as the benefits can vary depending on your financial situation and tax law changes.
- Other Deductible Expenses: In addition to mortgage interest, other common itemizable expenses include state and local taxes, medical expenses above a certain threshold, and charitable donations. These can help push your itemized deductions above the standard deduction.
Key Takeaways
Writing off mortgage interest is a powerful tool for homeowners, particularly in times of high interest rates. If your mortgage interest payments are significant, it might be worth exploring itemized deductions instead of the standard deduction to maximize your tax savings. It could help maximize your tax deductions when combined with other deductible items. By understanding your options and reviewing your financial situation annually, you can take full advantage of your homeownership benefits come tax time.
If you have any questions about your mortgage, what interest rate you’re paying, or what it costs you annually, please contact one of our loan advisors. As we continue to keep an eye on rates, you should be aware of what your current rate is so that when rates drop, you can be informed and prepared if you are interested in refinancing to secure a lower rate or even consolidate debt.