Is the Mortgage Tax Deduction in Your Best Interest?

So tax season is upon us, and if you’re paying on a mortgage, you probably feel pretty excited about the home mortgage tax deduction that comes with it. After all, everyone says that you should hold off on fully repaying your mortgage because the tax deduction saves you money. Unfortunately, that common sense advice isn’t really sensible at all, and may actually be costing you money.

The home mortgage tax deduction is a type of itemized tax deduction that allows you to reduce your taxable income by the amount you paid in interest. This deduction combines with all other itemized tax deductions and if that total exceeds the standard deduction it will take its place. Now, you can claim up to two homes for this deduction, and the definition of home only requires that it have a sleeping area, a cooking space, and a toilet. So, if own something, like a boat, that fits that definition, it could be worth claiming.

There are three major reasons that this deduction isn’t everything popular opinion has cracked it up to be. 1) It’s based on the interest you paid over the year, not the principal. 2) It’s an itemized deduction. 3) There is a major difference between the savings you get from the tax deduction and the total amount you will pay in interest over time.

Being based in the interest that you paid over the year is a problem because that amount decreases as you make payments on your mortgage. Interest is calculated over the life of the loan, so there is only so much interest to pay before you're paying down the principal itself. 

Itemized deductions can be problematic because they are cumulative and only replace your standard deduction if they exceed it. So, if the total of your itemized deductions is less than your standard deduction, claiming the home mortgage tax deduction isn’t actually benefiting you at all. Even if your total itemized deductions exceed your standard deduction, your taxable income will only be reduced by the difference between them. This calculator can help you determine how much your mortgage interest saves you in taxes. Now, even if it only results in a $200.00 difference it is still worth claiming, but know that the difference isn’t a direct reflection of the interest you paid.

Now let’s consider the cumulative factor. Let’s say you bought a $150,000 home and put $30,000 down, making your principal $120,000, for a 30 year mortgage with a 3.94% interest rate. Your monthly payment would be about $568.76. If you pay off the loan completely, you will have spent about $84,753 in interest over the 30 year loan, which averages out to about $235 a month or $2,825 a year. This means that in order for the home mortgage tax deduction and your other itemized deductions, to be truly profitable, there will need to be at least a $3,000 difference between your standard deduction and your itemized deductions.

It would take about 149 months, or 12 years and 4 months, to repay just the interest on the loan. So if you move frequently, and buy/sell your home each time, you're effectively only ever pay the interest on your home(s). The average American moves about every five years. If you fall into this category, consider how much you’re spending in interest. Depending on your life goals, this may not be problematic, but it may be worth holding off buying a home until you’re in an area you plan to stay in or waiting to move from your current home.

So if the only reason you are choosing not to repay your mortgage is because of the tax deduction,  rethink your strategy. Depending on your other itemized deductions, it could work out in your favor, but that isn't a guarantee. If you're focusing on repaying high interest debts, like credit cards, or building a nest egg, paying off your mortgage doesn't need to be priority. But when you can afford to, put extra money toward your mortgage, because you will reduce the overall interest paid and you won’t be losing much without filing a home mortgage tax deduction.

Written by Mckenzie Candalot, Staff Writer – Mckenzie Candalot graduated from the College of Idaho with a B.A. in English Literature. She has a passion for written language and helping other women take control of their finances. When not blogging or reading, she enjoys cooking and spending time with loved ones.