Mortgage interest deduction

Mortgage interest deduction is a money term you need to understand. Here’s what it means.

What is a mortgage interest deduction?

Mortgage interest deduction is the interest expense on a home loan that the government allows you to subtract from your income prior to computing your income tax, effectively reducing the amount of taxes you pay.

Deeper definition

Unlike other debts such as credit cards, mortgages are structured on an amortization schedule. This schedule breaks down how much of your monthly mortgage payment goes toward paying off the principal, the amount that goes into escrow for things like taxes and insurance, and finally, how much of your payment is applied to interest on the loan.

The proportion applied to interest changes over the life of the mortgage, because you pay more in interest during the early years of the mortgage.

When you file your taxes each year, you have the option of itemizing your deductions. It is almost always the best choice if you own a home because you are able to deduct the interest you paid to purchase, build or make improvements on the residence. You also can claim the deduction for rental properties you own and on loans for a second home or vacation home, provided you meet certain limitations.

The mortgage company will provide you with a Form 1098, showing your interest for the tax year, and you report it on Schedule A of Form 1040.

Consult our handy mortgage tax deduction calculator.

Mortgage interest deduction example

You have a choice to make at tax time: Take the standard deduction for your filing status or itemize. The smart move is to use whichever method cuts your tax burden most.

For example, if you are filing as a “married couple filing jointly” for the 2017 tax year, the standard deduction is $12,700. That’s the amount that automatically would be subtracted from your income and help to lower your taxes.

Because you cannot take the standard deduction and itemize, you must choose one. If you do the math and your allowable itemized deductions, including mortgage interest for up to two homes, state and local income or sales taxes, medical and dental expenses that exceed 7.5 percent of your adjusted gross income, charitable donations and property taxes, are greater than $12,600, you will benefit financially by itemizing. For most people, the ability to deduct their mortgage interest is the only reason they itemize.

Don’t overlook tax breaks of mortgage points.

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