Many people are drawn to owning a home because of the tax benefits. One of the most popular tax deductions people use is for mortgage interest on their home loans. But before you assume you'll be able to get a tax break from mortgage interest, there are several rules you need to understand.
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Requirements for Deducting Mortgage Interest
Only some types of mortgage interest are deductible on your taxes. If you don't meet all of the requirements for deducting mortgage interest, then you won't get any tax benefit.
- You must itemize: The deduction for mortgage interest is only available to those who itemize their deductions. If you take the standard deduction, and the total of your mortgage interest and other available itemized deductions is still less than the standard deduction, then you won't get an added deduction from paying mortgage interest.
- The deduction must be for a qualified home: You can't claim mortgage interest for an unlimited number of properties. In general, two homes can qualify: the main home in which you ordinarily live most of the time, and a second home, such as a vacation property. Those with more than two homes can name which one they want to treat as a second home for purposes of the deduction.
- You must stay within certain limits depending on use of loan proceeds: For a mortgage used to buy, build, or make major improvements to your home, you can deduct the interest on up to $1 million in mortgage debt, adding together outstanding debt on your main home as well as any second home. In addition, you can deduct interest on up to $100,000 more in home equity debt, which doesn't have to be related to the purchase or improvement of your home.
When the Mortgage Interest Deduction Is Less Valuable
Even though the tax law generally lets taxpayers deduct mortgage interest, whether you'll be able to deduct it can vary depending on several factors. They include the following.
- In low interest rate environments: When interest rates are low, you'll have less mortgage interest to deduct. Small amounts raise the chances that you won't have enough itemized deductions to make it worth itemizing, versus taking the standard deduction.
- During the later years of your mortgage: Early in your mortgage, the majority of your monthly payments go toward paying interest. But as you build equity in your home, more of the payment goes toward paying down principal. Principal payments are not deductible, so you'll find that the deductible portion of your mortgage payments falls over the years.
The mortgage interest tax deduction plays a big role in whether it makes financial sense to buy a home versus renting. To make a smart decision, though, you need to run the numbers to make sure you'll be able to deduct all of the mortgage interest you pay.
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The article Is Mortgage Interest Tax-Deductible? originally appeared on Fool.com.
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