Making sense of the mortgage interest deduction

What is the mortgage interest deduction?

The mortgage interest deduction is a tax benefit available to homeowners with a mortgage. It is an aspect of the U.S. tax code that allows you to deduct the interest you pay on any loan you may have used to buy, build or make improvements on your home—including second homes and vacation homes. Put simply, it helps homeowners reduce the amount they owe in taxes.

The amount you’ve paid in mortgage interest over the previous year is provided to you by your mortgage lender on tax Form 1098 and Schedule A of the 1040 tax form. Since 2018, the deduction is eligible on mortgages with a principle amount of $750,000 or less. 

You may hear that the deduction helps more people afford the costs of owning a home, but it is a myth to claim that it has helped expand homeownership since it was instituted. In fact, there is more than a fair bit of confusion about the mortgage interest deduction, including the answer to a very basic question: why do we have it?

History of the mortgage interest deduction

The history of the mortgage interest deduction is characterized by unintended consequences. It wasn’t with the goal of expanding homeownership in mind that Congress instituted the deduction. 

As early as the late-19^th century, Congress was passing laws to categorize all forms of interest as tax deductible. This was in a time before credit cards and other forms of personal debt were widely accepted, so most interest would have qualified as business-related. In fact, the great majority of homeowners didn’t have a mortgage—at that time the most common way to buy a home was in cash—paid-in-full.

Congress was hoping to support businesses by declaring that they could deduct all expenses, including interest. But they didn’t clarify that this was solely for businesses. The one clear difference between businesses and individuals is that businesses earn money, so those expenses lead to income that will eventually be taxed. Individuals don’t actively earn money by owning a home, and therefore the interest deduction isn’t offset by a taxable income.

It wasn’t until the post-WWII surge of homeownership, driven by returning GIs with access to the VA loan program, did anyone really take much notice of the mortgage interest deduction and consider it an added benefit of homeownership. This was the time that homeownership started to become equated with the American Dream, and this tax benefit became a central part of that.

Even the U.S. Department of Housing and Urban Development’s Office of Policy Development and Research cites the economic benefit of the mortgage interest deduction to reduce housing costs. 

How much you can expect to save

At this point, you’re probably wondering what type of economic benefit you can expect to see with the mortgage interest deduction. To get to the bottom of that, two facts need to be understood:

• The deduction is only available to taxpayers who itemize their returns.
• Only about 10% of tax filers itemized their returns during the 2018 tax season after the passage of the Tax Cuts and Jobs Act (TCJA).

Since the passage of the TCJA, the maximum mortgage principal eligible for deductible interest is $750,000. It had been $1 million. That law also made it easier for taxpayers to save more money on their returns by raising the standard deduction amount. That’s why the vast majority of taxpayers now take the standard deduction. 

But if your interest payments add up to quite a bit annually, it does make sense to itemize your deduction. You’ll likely be able to save more that way than with a standard deduction. It’s important, therefore, that you run the numbers.

Doing the mortgage deduction math

As an example, let’s say that you’re in the 22% tax bracket. To keep this simple, we’ll assume that you’re single without children. The standard deduction is $12,550 on 2021 taxes, so the value for you would be 22% of that–$2,761.

If you paid $10,000 in mortgage interest in 2021, the value of the deduction would be 22% of that. Therefore, you’d be able to deduct $2,200. That’s $561 less than you would qualify for if you had taken the simple way out and used the standard deduction. 

The best way to know which deduction is right for you, and how to take advantage of if, is to talk to a tax professional. 

While the mortgage interest deduction may have helped convince you to buy a home, the truth is that it doesn’t make much difference come tax time. If you qualify for more savings by itemizing your return, then you probably like this outdated aspect of our tax code. But if you’re like most, it just doesn’t apply.