Homeownership
has long been a part of the American dream, and it opens the door to benefits
like the mortgage interest deduction for those who itemize deductions on their
taxes.
Itemizing
typically makes sense only if itemized deductions on a primary and second home
total more than the standard deduction, which nearly doubled in 2018.
Here’s
what you need to know about the mortgage interest deduction.
Related: 6 simple ways to reduce your mortgage payment
What Is the Mortgage Interest Deduction?
The
deduction allows itemizers to count interest they pay on a loan related to
building, purchasing, or improving a primary home against taxable income,
lowering the amount of taxes owed.
The tax
deduction also applies if you pay interest on a condominium, cooperative,
mobile home, boat, or recreational vehicle used as a residence. The deduction
can also be taken on loans for second homes, as long as it stays within the
limits.
States
with an income tax may also allow homeowners to claim the mortgage interest
deduction on their state tax returns, whether or not they itemize on their
federal returns.
What Are the Rules and Limits?
The
passage of the Tax Cuts and Jobs Act of 2017 was a game-changer for the
mortgage interest deduction. Starting in 2018 and set to last through 2025, the
law greatly increased the standard deduction and eliminated or restricted many
itemized deductions.
For the
2021 tax year, the standard deduction is $25,100 for married couples filing
jointly and $12,550 for single people and married people filing separately. For
2022, the standard deduction is $25,900 for married couples filing jointly and
$12,950 for single people and married people filing separately.
If you
itemize deductions, you’re good to go and can deduct the interest. There’s
further good news, as you may also be able to deduct interest on a home equity
loan or line of credit, as long as it was used to buy, build, or substantially
improve your home.
The loan
must be secured by the taxpayer’s main home or second home and meet other
requirements. For tax purposes, a second home not used for income is treated
much like one’s primary home. It’s a home you live in some of the time.
The IRS
considers a second home that’s rented some of the time one that you use for
more than 14 days, or more than 10% of the number of days you rent it out
(whichever number of days is larger). If you use the home you rent out for
fewer than the required number of days, it is considered a rental property—one
that you never live in, and not eligible for the mortgage interest deduction.
Generally,
your interest-only mortgage is 100% deductible,
as long as the total debt meets the limits.
According
to the Internal Revenue Service, you can deduct home mortgage
interest on the first $750,000 ($375,000 if married filing
separately) of debt. Higher limitations ($1 million, or $500,000 if married
filing separately) apply if you are deducting mortgage interest from debt
incurred before Dec. 16, 2017.
You
can’t deduct home mortgage interest unless the following conditions are met.
•
You must 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.
Simply
put, your mortgage is a secured debt if you put your home up as collateral to
protect the interests of the lender. If you can’t pay the debt, your home can
then serve as payment to the lender to satisfy the debt.
A
qualified home is your main home or second home. The home could be a house,
condo, co-op, mobile home, house trailer, or a houseboat. It must have
sleeping, cooking, and toilet facilities.
Know
that the interest you pay on a mortgage on a home other than your main or
second home may be deductible if the loan proceeds were used for business,
investment, or other deductible purposes. Otherwise, it is considered personal
interest and is not deductible.
How Much Can I Deduct?
No doubt
you want the answer to that question. In most cases, you can deduct all of your
home mortgage interest. How much you can deduct depends on the date of the
mortgage, the amount of the mortgage, and how you use the mortgage proceeds.
The IRS
says that if all of your mortgages fit into one or more of the following three
categories at all times during the year, you can deduct all of the interest on
those mortgages. (If any one mortgage fits into more than one category, add the
debt that fits in each category to your other debt in the same category.)
1. Mortgages you took out on or before
Oct. 13, 1987 (called grandfathered debt).
2.Mortgages you (or your spouse if
married filing jointly) took out after Oct. 13, 1987, and prior to Dec. 16,
2017, to buy, build, or substantially improve your home, but only if throughout
2020 these mortgages plus any grandfathered debt totaled $1 million or less
($500,000 or less if married filing separately).
3. (There is an exception. If you
entered into a written contract before Dec. 15, 2017, to close on the purchase
of a principal residence before Jan. 1, 2018, and you purchased the residence
before April 1, 2018, you are considered to have incurred the home acquisition
debt prior to Dec. 16, 2017.)
4. Mortgages you (or your spouse if
married filing jointly) took out after Dec. 15, 2017, to buy, build, or
substantially improve your home, but only if throughout 2020 these mortgages
plus any grandfathered debt totaled $750,000 or less ($375,000 or less if
married filing separately).
The dollar limits for the second and
third categories apply to the combined mortgages on your main home and second
home.
What Are Special Circumstances?
Life
sometimes isn’t black or white, but gray. Just like you need to understand your
home loan options, you need to know the special situations where the IRS says
you might or might not qualify for the mortgage interest deduction.
You can deduct
these items as home mortgage interest:
- A late payment charge if it wasn’t for a specific service
performed in connection with your mortgage loan. - A mortgage prepayment penalty, provided the penalty wasn’t for a
specific service performed or cost incurred in connection with your mortgage
loan.
You cannot deduct the interest paid for you if you qualified for mortgage
assistance payments for lower-income families under Section 235 of the National
Housing Act
Is Everything Deductible?
The
government is only so generous. There are a lot of costs associated with
homeownership. Many of them are not tax deductible under the mortgage interest
deduction, like homeowners insurance premiums.
One
caveat: You might be able to write off a portion of insurance, as well as
utilities, repairs, and maintenance, if you have a home office and deduct those
expenses on Schedule C.
Also,
not on the list for inclusion in the mortgage interest deduction are title
searches, moving expenses, and reverse mortgage interest. Because interest on a
reverse mortgage is due when the property sells, it isn’t tax deductible.
How to Claim the Mortgage Interest
Deduction
An
itemizer will file Schedule A, which is part of the standard IRS
1040 tax form. Your mortgage lender should send you an IRS 1098 tax
form, which reports the amount of interest you paid during the tax year. Your
loan servicer should also provide this tax form online.
Using
your 1098 tax form, find the amount of interest paid and enter this on Line 8
of Schedule A on your tax return. It’s not a heavy lift but gets a tad more
complicated if you earn income from your property. If you own a vacation home
that you rent out much of the time, you’ll need to use Schedule E.
Furthermore,
if you’re self-employed and write off business expenses, you’ll need to enter
interest payments on Schedule C.
The Takeaway
You can
take the mortgage interest deduction if you itemize deductions on your taxes.
Keep in mind that it’s typically only worth taking if the write-offs exceed the
standard deduction.
The
mortgage interest deduction, though, can be a bonus of sorts, especially if
you’re a homeowner with a second home.
As with
all matters that affect your taxes, you’ll want to consult with your financial
advisor about claiming the deduction.
Learn more:
- Understanding the different types of mortgage loans
- What is a piggyback mortgage loan & how does it work?
This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.
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Terms, conditions, and state restrictions apply. SoFi Home Loans are not
available in all states.
External Websites: The information and analysis provided through hyperlinks to
third party websites, while believed to be accurate, cannot be guaranteed by
SoFi. Links are provided for informational purposes and should not be viewed as
an endorsement.
Tax Information: This article provides general background information only and is
not intended to serve as legal or tax advice or as a substitute for legal
counsel. You should consult your own attorney and/or tax advisor if you have a
question requiring legal or tax advice.
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What is mortgage amortization?
If you’re looking into getting a mortgage for the first time, congratulations! You’re about to embark on a brave new adventure in adulthood. Like most adventures, it comes with some highs and some lows.
One of the highs might be when you finally find the perfect home in your price range. As for the lows, one of them could well be trying to understand all the jargon that’s involved in buying a house.
Home-buying terminology can be somewhat intimidating. What’s the difference between prequalification and preapproval? Why are there so many different types of mortgage loans? What in the world is escrow? And what does amortized mean?
Related: Tips when shopping for a mortgage
DepositPhotos.com
We’re going to answer that last question, quickly and painlessly. Basically, mortgage amortization just means that your mortgage loan payments will be spaced out over a set period of time (often 30 years) and will be calculated so that you always pay the same amount per month (if you have a fixed rate mortgage, not a variable rate mortgage).
That means that if you get a fixed rate mortgage and your first payment in your first month is $1,500, you know that you’ll pay $1,500 in the last month of your mortgage, years later. If you take out a variable rate mortgage, the amount you pay each month will change periodically as the market rate fluctuates.
Just because you’re paying the same amount for your fixed rate mortgage each month doesn’t mean that your payment is going toward the same things each month. In fact, your first mortgage payment will go primarily toward interest, and your last mortgage payment will go primarily toward the principal.
Throughout the life of your loan, this balance paying off interest to paying off principal will gradually shift as more of your principal is paid off (and therefore generates less interest).
Chainarong Prasertthai // istockphoto
Mortgage amortization helps ensure that your obligations are predictable, which can make it easier for you to plan. If you take out a 30-year mortgage, then the amortization helps guarantee that in 30 years, you will have finished paying it off.
For a fixed rate mortgage, amortization also keeps all your payments consistently the same amount, rather than different amounts that depend on how much your principal is.
SARINYAPINNGAM / istockphoto
In real life, even if you choose an amortized mortgage, you may never need to figure out your 30 years or so of payments yourself. But it’s useful to see what goes into the table or payments (they’re not arbitrary!) and understand how it’s populated. Calculating your amortized mortgage really puts you on the front lines of homebuying.
Let’s say you take out a $100,000 mortgage over 10 years at a 5% fixed interest rate. That means your monthly payment will be $1,061. You can then divide your interest rate by 12 equal monthly payments. That works out to 0.4166% of interest per month. And that, in turn, means that in the first month of your loan, you’ll pay around $417 toward interest and the remaining $644 toward your principal.
Next, to calculate the second month, you’ll need to deduct your monthly payment from the starting balance to get the ‘balance after payment’ for the chart. You’ll also need to put the $417 you paid in interest and $644 you paid toward the principal in the chart. Then you can repeat the calculation of your monthly interest and principal breakdown, and continue inputting until you finish completing the chart.
Gerasimov174 / istockphoto
So you can see that it’s not so much difficult to calculate your amortized payments as it is time-consuming. Fortunately, you can save yourself the trouble by using an online amortization calculator.
All you have to do is input info about your mortgage, including the amount you’re borrowing, your term length, and the interest you’re paying, and the calculator will do the math for you.
Mykola Komarovskyy/shutterstock
1. You’ll slowly but surely pay off the principal of your home loan
With every month, you’ll get closer to owning your home outright!
2. It ensures that you pay a set amount for each payment over the life of your loan
With some loans you may end up paying more at the beginning or the end. A balloon mortgage, for example, requires you to pay interest charges monthly during the regular term. You then pay off large parts of the principal at the end of the loan period. (Thus, your payment literally balloons.)
3. You can often get better terms with an amortized loan
And you’ll save money in the long run by paying less interest over the life of your mortgage.
DepositPhotos.com
1. Larger down payments
Amortized mortgages favor borrowers who are putting down a larger down payment. To qualify for a competitive interest rate, you’ll probably need to put down 10% (if not 20%).
2. It’s harder to qualify
You might not be able to qualify to borrow as much money via an amortized mortgage as you would through an alternative mortgage, such as an interest-only mortgage or a balloon mortgage.
Learn More:
This article originally appeared on SoFi.comand was syndicated by MediaFeed.org.
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SoFi Home Loans
Terms, conditions, and state restrictions apply. SoFi Home Loans are not available in all states. See SoFi.com/eligibility for more information.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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