Mortgage Interest: What You Can Deduct on Taxes

Buying a home can change more than your monthly budget. Mortgage interest may also affect your federal income taxes, but the deduction is not automatic. To claim it, you generally need to itemize deductions, have a qualifying loan, and keep records that support the amount reported on your return.

For many homeowners, the key question is simple: Will itemizing save more than taking the standard deduction? The answer depends on your mortgage interest, state and local taxes, charitable gifts, medical expenses in some cases, and your filing status. Here is how the mortgage interest deduction works and what to check before you file.

When mortgage interest is deductible

You may be able to deduct interest paid on a loan secured by a qualified home. A qualified home can be your main home or one second home, such as a vacation property. The home can be a house, condominium, cooperative apartment, mobile home, houseboat, or similar property, as long as it has sleeping, cooking, and toilet facilities.

The loan must be secured by the home. In practical terms, that usually means the lender could foreclose on the property if you do not repay the loan. A mortgage used to buy, build, or substantially improve your main home or second home generally meets the purpose test for deductible home acquisition debt.

The deduction applies to interest you actually paid during the tax year. Your payment may include principal, interest, property taxes, homeowners insurance, and other charges, but only the qualifying interest portion is part of the mortgage interest deduction.

Mortgage interest limits to know

The amount of debt eligible for the deduction is limited. For mortgages taken out after December 15, 2017, the general limit is interest on up to $750,000 of qualified home acquisition debt. The limit is generally $375,000 if you are married filing separately.

Some older mortgages may qualify for the higher $1 million debt limit if they were incurred on or before December 15, 2017. The lower limit generally applies to refinancing as well, although a refinance of grandfathered debt may preserve the older limit up to the remaining principal balance of the original loan.

These limits matter most when your mortgage balance is high. If your qualified debt exceeds the applicable limit, you may still deduct part of your interest, but not all of it. Tax software can help calculate the allowable amount when the limitation applies.

Home equity loan and home equity line of credit interest can also be deductible, but how you used the money matters. The proceeds generally must have been used to buy, build, or substantially improve the home that secures the loan. Using home equity funds to pay credit cards, cover a vacation, or pay college tuition does not usually create deductible mortgage interest.

You must itemize deductions

Mortgage interest is claimed on Schedule A, Itemized Deductions, filed with Form 1040. You cannot claim this deduction if you take the standard deduction instead.

That does not mean homeowners should automatically itemize. Add your allowable mortgage interest to your other itemized deductions, then compare that total with the standard deduction for your filing status and tax year. Choose the option that gives you the larger deduction.

For example, suppose a single taxpayer has $9,000 in qualifying mortgage interest, $6,000 in deductible state and local taxes, and $1,500 in charitable contributions. Their potential itemized deductions total $16,500 before considering other limits. If that amount exceeds their standard deduction, itemizing may lower taxable income. If it does not, the standard deduction may produce a better result.

Property tax is separate from mortgage interest, even when both appear in your monthly escrow payment. Property taxes may be itemized on Schedule A as state and local taxes, subject to the applicable federal limit. Do not combine the two amounts or assume every escrow charge is deductible.

Use Form 1098 when you prepare your return

Your mortgage lender will generally send Form 1098, Mortgage Interest Statement, if you paid $600 or more of mortgage interest during the year. The form typically shows the interest paid in Box 1 and may show deductible points in Box 6.

Review the form against your own records, especially if you refinanced, sold your home, changed lenders, or made unusual payments. You may receive more than one Form 1098 if your loan was transferred during the year. Be sure to account for all qualifying forms.

A Form 1098 is helpful documentation, but it does not decide your deduction by itself. You still need to meet the rules for a qualified home, qualifying debt, and itemized deductions. If your lender did not issue a form, you may still have deductible interest if you can document the payment and meet the requirements.

How points affect your tax return

Points are prepaid interest charges that can reduce a mortgage’s interest rate. Whether you deduct points all at once or over time depends on the loan and how the funds were used.

Points paid on a loan to buy or build your main home may be fully deductible in the year paid if several IRS requirements are met. For instance, charging points must be an established business practice in your area, and the points generally must be calculated as a percentage of the loan amount.

Points paid to refinance a mortgage are usually deducted gradually over the life of the new loan instead of all at once. If you use part of a refinance loan for substantial home improvements, the treatment may differ for the portion related to those improvements. This is an area where entering the Form 1098 details carefully in your tax software can prevent an avoidable error.

Common mortgage interest mistakes

The most common mistake is entering the full amount on Form 1098 without checking whether you are eligible to itemize. A taxpayer can have a valid Form 1098 and still receive a larger tax benefit from the standard deduction.

Another mistake is treating all home-related borrowing as deductible. Interest on personal loans, credit cards, and unsecured lines of credit is generally not deductible simply because you used the money for your home. Likewise, interest on home equity debt used for personal expenses is generally not deductible as qualified residence interest.

Homeowners should also be careful when a mortgage is shared. If two unmarried owners pay a mortgage together but the Form 1098 lists only one person, each owner may be able to deduct the share they actually paid if they otherwise qualify and have documentation. Do not both claim the same interest payment.

Mortgage insurance premiums should not be entered as mortgage interest unless tax law for the filing year specifically allows a deduction. Federal treatment of these premiums has changed over time, so check the instructions for the return you are filing rather than relying on an older tax return.

Keep records beyond tax season

Keep Form 1098, closing disclosures, refinancing documents, loan statements, and proof of how home equity funds were used. These records are especially useful if you have a high loan balance, deduct points, refinance, or take out a home equity line of credit.

If you sell the home later, records of purchase costs and qualifying improvements can also help calculate your gain or loss. Mortgage interest itself does not increase your home’s tax basis, but your closing and improvement records may be important for other reasons.

Rental properties follow different rules. Interest related to a rental home is generally reported with rental income and expenses rather than as an itemized deduction on Schedule A. If a property is used partly as a home and partly as a rental, the expenses may need to be divided based on use.

Before you file, gather every Form 1098 and compare your total itemized deductions with the standard deduction. A few minutes spent checking the loan purpose, debt limit, and point treatment can help you claim the mortgage interest deduction correctly and file with more confidence.