Mortgage interest deduction

One of the biggest advantages of homeownership over renting is being able to use the mortgage interest deduction to reduce your taxes. The government allows taxpayers to deduct the interest paid on their mortgages as an incentive to increase homeownership.

But with changing interest rates and updates to tax laws, is the mortgage interest deduction as valuable as it once was? Learn more about this tax deduction, how to deduct it for the 2022 tax year and if it is still worth it.

Key insights

• Homeowners can deduct mortgage interest on their primary or secondary residence on loans up to $1 million.
• Eligible borrowers may also deduct mortgage points and property taxes.
• With changes in tax laws, you may be better off taking the standard deduction instead.

What is the mortgage interest deduction?

The mortgage interest deduction is the ability to use the interest paid on the mortgage of your primary or secondary home to reduce your taxable income. Some homebuyers use the tax savings to increase their buying power when buying a new home.

Cindi Conley, a 30-year mortgage lender and creator of Mortgage and Money Talk, a website with mortgage advice, says that the mortgage interest deduction is "a tax incentive for homeowners that allows them to reduce their tax liability."

This deduction may reduce your taxable income and taxes owed, depending on how you file, when the mortgage originated, how much you owe and what the money was for.

What qualifies for a mortgage interest deduction?

Interest on purchase mortgages, refinanced mortgages and secondary mortgages may be eligible for a tax deduction. Qualifying for the mortgage interest deduction depends on four major factors: which property the mortgage is on, when the mortgage originated, how much the mortgage is for and how you use the proceeds.

• Primary or secondary residence: Mortgage interest is eligible for a deduction if the mortgage secures your primary or secondary residence. Secondary residences include vacation or seasonal homes that a borrower lives in for part of the year.
• When the mortgage originated: There are different tax rules for deduction limits based on when the mortgage originated.
• Mortgage amount: The maximum mortgage debt you can claim interest on is $750,000, or $1 million for homeowners who incurred home mortgage debt before Dec. 16, 2017.
• How you use the proceeds: You may deduct interest on mortgages originated after Oct. 13, 1987, if the funds were to buy, build or substantially improve your home.

In addition to mortgage interest, special situations allow you to deduct other eligible expenses related to your home:

• Mortgage points paid: Points paid on your mortgage are prepaid interest. Therefore, the amount paid is spread out over the life of the mortgage.
• Late payment charges: You can include late charges on your mortgage in the total interest paid for that year.
• Mortgage prepayment penalty: If you prepay a mortgage that charges a penalty for early payments, you can include those charges as interest.
• Sale of home: Your mortgage interest deduction amount includes interest paid up to, but not including, the sale date.

Taxpayers have to analyze whether they are better off using the standard deduction or itemizing their deductions. As of 2022, taxpayers can no longer deduct mortgage insurance premiums when they itemize their deductions. Additionally, interest on home equity loans and lines of credit are deductible only if the funds were to buy, build or substantially improve your home.

How much interest can you deduct?

The amount of mortgage interest that you can deduct depends on when the mortgage originated. There are three main categories of mortgages:

• On or before Oct. 13, 1987: These mortgages are "grandfathered" in and do not have any debt limitations.
• Through Dec. 15, 2017: You can deduct interest on mortgages used to buy, build or substantially improve your home on up to $1 million in total mortgage debt. Taxpayers who are married but file separately may deduct up to $500,000 in mortgages.
• After Dec. 15, 2017: Mortgages originated after this date used to buy, build or substantially improve your home are capped at $750,000 for interest deductions. Taxpayers who are married and filing separately can only deduct interest on $375,000 in mortgage debt.

For homeowners with mortgages higher than these limits, you must calculate the proportional interest charges to determine how much you can deduct.

The Tax Cuts and Jobs Act (TCJA) of 2017 lowered the mortgage deduction limit for all new mortgages to $750,000. However, there is an exception for homebuyers who entered into a written binding contract prior to Dec. 15, 2017, with a close date of Jan. 1, 2018, or sooner. As long as you’ve completed the purchase by April 1, 2018, the mortgage interest deduction limit is $1 million instead of $750,000.

With the passing of the TCJA of 2017, the standard deduction nearly doubled, to $12,000 for single filers and $24,000 for joint filers. These amounts increased to $12,950 and $25,900, respectively, for the 2022 tax year. With these higher limits, many homeowners find it easier or more advantageous to use the standard deduction instead of taking the mortgage interest deduction.

How to take the mortgage deduction on your tax return

If you're interested in taking the mortgage interest deduction on your tax return, follow these steps:

• Obtain Form 1098 from your lender. Ensure that it lists the mortgage origination date, ending loan balance and interest paid. This document should also include any points paid on your loan.
• Get the right tax forms. Detail your itemized deductions on Schedule A, including mortgage interest, property taxes, eligible medical and dental expenses, state and local income taxes, and other eligible items.
• Compare standard versus itemized deduction. The standard deduction for 2022 is $25,900 for joint filers or $12,950 for single filers or those married and filing separately. Compare your Schedule A totals versus the standard deduction. In most cases, your federal income taxes owed will be less if you take whichever is larger – the standard deduction versus itemizing.

Bottom line

As a homeowner, you have the opportunity to deduct the mortgage interest that you pay each year. Tax laws define who is eligible for this deduction based on when you got your mortgage, how much you borrowed and what the money was used for.

Before claiming this deduction, compare your itemized deductions against the standard deduction to determine which one is more beneficial. Because everyone's situation is different, consider consulting with a tax professional or financial advisor to help you decide the best approach for your situation.