Tax deductions help countless Americans hang onto more of their hard-earned money. If you're a homeowner, you should know that there are numeroustax breaks that might be available to you, the most potentially lucrative of which is the mortgage interest deduction. Just how much is the mortgage interest deduction worth? It depends on how much interest you pay in a given year and what your tax bracket is. Here, we'll help you calculate your deduction so you know how much home interest to write off on your taxes.
How tax deductions work
As a quick refresher, tax deductions work by excluding part your income from taxes. If you take a $10,000 tax deduction, it means you don't need to pay taxes on that portion of your earnings. Now if your effective tax rate is 25%, a $10,000 deduction will translate into $2,500 of savings. But if you're a higher earner, and your effective tax rate is 33%, that deduction will give you $3,300 in savings.
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The mortgage interest deduction
Before you calculate your mortgage interest deduction, you should know that if you have a larger loan, you may not be eligible to write off your interest in full. You can deduct mortgage interest on a loan worth up to $500,000 if you're a single tax filer, or $1 million if you're filing a joint return. Most homeowners' mortgages don't exceed these limits, but it's something to be aware of if you're financing a pricier property.
Now for the most part, calculating your mortgage interest isn't something you need to do yourself. Rather, your mortgage lender should send you an annual statement listing your principal and interest payments for the year. However, if you're missing that form or want to be proactive in figuring your tax savings, we have a helpful calculator that can help you crunch those numbers. All you need to do is enter your loan amount, your interest rate, the term of your loan (15-year, 30-year, or something else), and your tax bracket. From there, the calculator will estimate your mortgage interest deduction on a year-by-year basis.
So if, for example, you're looking at a $200,000, 30-year fixed loan at 4% interest, and a tax rate of 25%, you can expect to save close to $36,000 in taxes over the life of your loan. Furthermore, the bulk of your savings will occur during the early years of your mortgage.
The reason? When you first start making payments, the majority of what you pay is applied to the interest portion of your loan, not its principal. Over time, that breakdown will shift, and during the final years of your mortgage, the bulk of your payments will be applied to your loan's principal portion, as opposed to its interest.
In other words, your mortgage will serve as a larger tax break in its early years, as opposed to when you're closer to having paid it off. In our example, if you were to take out a $200,000, 30-year loan at 4% interest, you'd get to take a mortgage interest deduction of $7,936 your first year, but just a $244 deduction your final year. And if your effective tax rate is 25%, you'd save $1,984 in taxes that first year, but a meager $61 your last year.
Though owning a home is an expensive undertaking, it can be rather rewarding from a tax perspective. In addition to taking a mortgage interest deduction, homeowners are also eligible to write off their property tax payments, which, in some parts of the country, can be significant. It pays to read up on the tax benefits of homeownership so you can maximize your savings when you file your return.
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