First, let’s clear up what mortgage interest is exactly. According to the Internal Revenue Service, home mortgage interest is any interest you pay on a loan secured by your property, meaning you offer that property as collateral for the money borrowed. This can be your primary home or a second home.
The mortgage interest deduction is a tax benefit available to homeowners itemizing their federal income tax deductions — you can’t deduct mortgage interest and take the standard deduction. As the name implies, it allows borrowers to deduct the interest (not the principal) they pay on their mortgages. It’s important to note that a tax deduction is different from a tax credit. For example, if you owe $2,000 in taxes and get a $200 tax credit, then you’re now obligated to pay only $1,800. However, if you get a $200 deduction, you only save a percentage of that amount, depending on your income tax bracket.
Because the interest you pay on your home loan could end up shrinking your tax bill, it’s crucial to keep accurate records. The mortgage interest deduction allows you to reduce your taxable income by the amount of money you’ve paid in mortgage interest during the year. But the interest you pay doesn’t remain the same — it decreases a bit monthly as more of your payment goes toward the principal. So, the mortgage interest deduction saves you a greater amount of money at the start of your loan.
Tax law changes impact mortgage interest deduction
Keep in mind that the Tax Cuts and Jobs Act (TCJA), signed in 2017, changed individual income tax by lowering the mortgage deduction limit and capping the amount you could deduct from your home equity loan debt. If, for example, you bought your house before the TCJA, specifically prior to Dec. 16, 2017, the mortgage interest deduction limit was $1 million. If you purchased the property after Dec. 16, 2017, you could deduct the interest you paid during the year on the first $750,000 ($375,000 for single taxpayers or married and filing separately) of the mortgage. Again, you can apply these mortgage interest deductions for primary or secondary loans. On the other hand, any interest paid on first or second mortgages over this amount is not deductible. Remember, homeowners with existing mortgages on or before Dec. 16, 2017, can still deduct interest on a total of $1 million of debt for a first and second home — $500,000 for single taxpayers or married and filing separately.
In addition, homeowners may no longer deduct interest paid on home equity loans, which was allowed for loans up to $100,000 before the TCJA, unless the taxpayer uses the debt to buy, build, or substantially improve the home that secures the loan.
You should note that these changes are due to expire at the end of 2025. At which point, the elements of the rewritten tax code will be up for renewal by Congress.
What about mortgage refinancing?
Yes, you can refinance a mortgage debt up to $1 million that existed before Dec. 15, 2017, and still deduct the interest. Generally, however, the new loan can’t exceed the amount of the mortgage you’re refinancing. So, for example, let’s say you have a $500,000 mortgage that you’ve paid down to $300,000, then you can refinance up to $300,000 of debt and still deduct the interest on that amount. Now, if you refinance for $400,000 and use $100,000 of that cash to make some substantial home improvements, you also can deduct the interest on the $400,000. However, if you refinance for the larger amount and decide to stash $100,000 in your bank account, you can only deduct the interest on the $300,000.
What qualifies as substantial home improvements?
You can consider an improvement substantial if it does one or more of the following:
- Adds to the value of the property
- Prolongs the home’s useful life
- Adapts the home to new uses
What improvements don’t qualify as substantial?
Maintaining the home in good condition doesn’t count. For instance, painting your bedroom robin’s egg blue to match the new duvet won’t qualify. However, painting the interior and exterior of the new kitchen and dining room addition most likely will.
Note that to determine the cost of home improvements, you should include not only building materials but also fees for architects and design plans as well as any building permits.
Interest deductions on home-equity loans and lines of credit (HELOCs)
Before 2018, homeowners could deduct the interest on up to $100,000 of home-equity debt used for any purpose. But today, the law prohibits interest deductions for these types of debts unless the money is used for specific home improvements.
For the borrowed funds to be eligible as a deductible, they must now be used to purchase, build, or substantially improve a first or second home. In addition, the debt must be secured by the property it applies to, so you can’t use a HELOC on a first home to buy or remodel a second home.
Conditions for deducting mortgage interest
You must meet these two conditions before you can deduct home mortgage interest:
- File Form 1040 or 1040-SR and itemize deductions on Schedule A (Form 1040)
- The mortgage must be a secured debt on a qualified home in which you have an ownership interest
What is a secured debt?
To take a home mortgage interest deduction, you must have your name on the loan. For instance, if Tom and Mary buy a house together, and both of their names are on the loan, they each are eligible to deduct the interest. But if Mary’s father, Bill, is making his daughter’s house payments, but only Mary’s name is on the loan, Bill cannot write off the mortgage interest – even if he’s the one paying for the house. In other words, the borrowers must be contractually obligated to the debt and be responsible for making the loan payments to take advantage of the write-offs.
Can I deduct mortgage interest if I live in a mobile home?
Absolutely. Not only can you deduct your home mortgage interest if you have a mobile home, but as long as it meets the necessary qualifications, the property can be a house, condo, co-op, house trailer, boat, or any similar property with sleeping, cooking, and toilet facilities.
What else qualifies as mortgage interest deductions?
First, to be sure that you’re following the tax laws and rules to the letter, because remember they can change, check with either a tax professional or refer to IRS Publication 936 for further details. Along with those mentioned earlier, eligible deductions could include the following:
- Nontaxable housing allowances for military members and ministers
- Mortgage taken to buy out an ex-spouse’s half of a property in a divorce settlement
- Late payment fees
- Mortgage insurance premiums, as long as your adjusted gross income is below a certain amount
- VA funding fee
- Mortgage discount points — a type of prepaid interest on your loan. You can deduct points over the life of the mortgage, or if you meet certain requirements, you can deduct them all at once
What doesn’t qualify as a mortgage interest deduction
- Homeowners insurance
- Extra principal payments
- Title insurance
- Settlement costs (most of the time)
- Deposits, down payments, or earnest money that you forfeited
- Interest accrued on a reverse mortgage
How do I know the interest amount I paid for the year?
Check your mortgage interest statement, which is IRS Form 1098. Look for it each January or February. Your lender mails one copy to you and one to the IRS.
Tax issues are finicky, and you need to follow them with absolute precision. With that in mind, always seek out the advice of a tax pro to make sure you’re claiming this deduction according to IRS regulations.