Are There Tax Benefits to a Mortgage
A mortgage is a significant financial commitment that you will likely be paying off for decades to come after purchasing a house, and for that reason, it can be quite daunting. However, the benefits of homeownership are many, and on a day-to-day and month-to-month basis, a mortgage is quite an affordable investment for most Americans. However, since the overall cost of a mortgage is quite large, one question we see very often is this: what mortgage tax benefits exist? It makes sense. Homeowners want to know if they can save money paid to Uncle Sam if they’re paying off a mortgage.
In this blog post, we’ll look at the tax benefits of a mortgage and when it makes sense to start taking advantage of them.
Can You Get Mortgage Tax Benefits When Buying a House?
If you’re here for a short answer (a very short answer), it’s this: yes! The federal government offers tax benefits to people paying off a mortgage.
The longer answer is this: You can deduct the interest you pay on your mortgage from your annual income, potentially letting you pay less in taxes. However, there are limits to this, and you may wind up being better off taking the “standard deduction” when you submit your taxes each year.
Let’s dive deeper into how mortgage tax benefits work.
Paying Off Your First Mortgage
You can’t deduct what you pay for the mortgage principal, but you can deduct any additional interest you pay. Due to how mortgage payments are calculated, the portion of interest-to-principal early on in your mortgage will be much higher than toward the end of your mortgage. So this will almost certainly be more beneficial to you early on.
The federal government allows you to deduct interest paid on mortgage debt of up to $750,000 for a married couple filing jointly or for an individual taxpayer, $375,000 (if you’re a couple filing separately, you can each deduct to a maximum of $375,000). So if you’re buying a home worth more than $750,000, be aware that you won’t be able to deduct the full amount of the interest you pay over the lifetime of your mortgage.
Are There Tax Benefits to a Second Mortgage?
Beyond deducting the interest you pay from your total taxable income, you’re simultaneously able to deduct interest on a second mortgage or HELOC (home equity line of credit) with one critical condition: both loans must have been made toward building, purchasing, or improving your home or homes.
The $750,000 limit also applies here, and it’s cumulative. Your total mortgages must be less than that when combined. So if you have two $400,000 mortgages, you will only be able to deduct the interest on the first $750,000, not the last $50,000.
To illustrate this with an example:
Let’s say you have a first mortgage, which you took to purchase a home worth $300,000, and you decide that you want to borrow against your home equity in a HELOC for funds to fix up and modernize an older home you inherited from a distant relative. As long as your HELOC has a value of less than $450,000, you can deduct the interest on both of these, no problem.
However, if, for instance, you took out a HELOC to pay off debts that were not related to buying, building, or improving a home, like student loans or car payments, you would not be able to deduct any of it on your taxes.
Deducting Mortgage Points from Your Taxes
You may also be able to deduct mortgage points from your overall tax burden when filing taxes. If you aren’t familiar with mortgage points, much less their tax benefits, they are fees paid up-front to reduce the overall interest rate that you must pay on your mortgage. You can learn more about mortgage points here.
Typically, a mortgage point is 1% of the total value of your loan (so, on our hypothetical $300,000 mortgage, it would be $3,000) and will reduce your interest rate by a flat amount. As we’ve previously discussed, reductions in mortgage interest rates can save you quite a lot of money over the long lifetime of a mortgage, so if you have cash on hand, mortgage points can sometimes be a very good deal if you can absorb the blow to liquidity.
Since mortgage points are essentially paying off part of your interest in advance, the federal government will let you deduct them as well, though you still cannot exceed the total cap of $750,000 over the life of the loan. They may be deducted gradually rather than all at once, depending on some criteria outlined by the IRS. You can learn more about mortgage points and see if yours might be deductible on the IRS site.
The Standard Deduction Might Be Better, Though
As we’ve covered over the course of this blog, you have many options when it comes to mortgage tax benefits: first mortgages, HELOCs, mortgage points, and more. However, for many homeowners, it may serve them better to take the standard deduction instead.
The standard deduction is something that all American taxpayers can choose to take instead of itemizing their deductions one by one. The standard deductions for the 2020 tax year will be:
- $12,400 for single individuals and married taxpayers who file separately
- $18,650 for heads of households
- $24,800 for a married couple filing jointly
Therefore, unless your mortgage tax deduction (combined with other deductions, like travel or home office expenditures) would equal or exceed the totals above, you may simply be better off using the standard deduction. It’s entirely possible that this will not only be much simpler when it comes to filing, but also could save you money.
However, this depends entirely on you, your mortgage, and your other expenses. So be sure to carefully research your options before filing taxes next year
The mortgage tax benefits are not massive, but they do exist, and they can certainly be helpful if you aren’t taking the standard deduction. If you have any questions about mortgage tax benefits, feel free to contact the experts at Rivermark Community Credit Union.