This article has been updated for the 2022 and 2023 tax years. At some point every single one of us has heard the advice, “Buy a home, so you can get the tax deduction”. The popularity of this advice ranks right up there with the “Buy a home, it’s a good investment” meme. In fact, many people argue that a home is a good investment precisely because of the mortgage tax deduction possibilities.
But as we discovered, your home is not an investment (at least not a good one).
Will the mortgage tax deduction advice hold up under closer inspection? Before I give you some examples, I want to first clarify the basics on the mortgage tax deduction is and when you could claim it.
What is a Mortgage Tax Deduction?
When you get a mortgage, you are often paying insane amounts of interest in that mortgage. Banks front load the mortgage with higher interest amounts in the beginning of the mortgage which taper off over the years. They do this so they can get more money out of each mortgage in the event the debtor were to pay off the loan early.
On the mortgages I’ve held, almost two-thirds of the total payment in the first 5 or more years of the loan were interest payments. The other third goes to paying down the principal (what you actually owe) on the house. It’s highway robbery (but that’s a different story for a different day). If you ever want to self induce vomiting, look at a mortgage amortization schedule, which will show you how much of your monthly payment is interest vs principal for each month of the loan.
You must also understand the difference between a tax credit and a tax deduction. A credit is getting the full dollar amount of taxes owed returned to you. A deduction is subtraction from your taxable income (what you actually end up being taxed on based on your tax bracket). Mortgage interest is tax deductible, not a tax credit.
A mortgage tax deduction is the amount of interest you pay on your mortgage, which you then can deduct from your taxable income total. Note that post tax reform in 2018, there were limits placed on how much mortgage interest you can deduct. You can deduct home mortgage interest on the first $750,000 ($375,000 if married filing separately) of indebtedness. However, higher limitations ($1 million ($500,000 if married filing separately)) apply if you are deducting mortgage interest from indebtedness incurred before December 16, 2017. Additionally, you can no longer deduct mortgage insurance premiums.
The Standard Deduction
It’s absolutely essential to note that you can only claim the mortgage tax deduction if you itemize your taxes. In reality, only about 35% of taxpayers did before tax reform, and post-tax reform that number has been just over 11.4%. If you are like the other 89% of the taxpaying population that claims the standard deduction, you cannot also add on the mortgage tax deduction. So right there, 90% of the population will not (or is not benefiting) from mortgage tax deductions.
How much is the standard deduction you will have to surpass to make it worth it?
2022 standard deductions:
- $12,950 for single filers
- $12,950 for married, filing separately
- $25,900 for married filing jointly
- $19,400 for head of household
2023 standard deductions:
- $13,850 for single filers
- $13,850 for married, filing separately
- $27,700 for married filing jointly
- $20,800 for head of household
The standard deduction was recently almost doubled due to tax reform.
The SALT Deduction Limit Further Limits the Benefits of Homeownership
As a result of the 2018 tax reform law, the state and local tax deduction (aka the “SALT deduction”), including property taxes, is now limited to $10,000 ($5,000 per person if “married filing separately”). Previously, 100% of SALT tax payments were deductible if you itemized your taxes, unless you were subject to the alternative minimum tax (AMT). Similar to the mortgage tax deduction, you can’t double dip (claim the property tax deduction and the standard deduction).
Running the Numbers on the Mortgage Tax Deduction Benefit
Let’s take a hypothetical situation to crunch some numbers. We’ll assume:
- You take out a $200K mortgage @ 7% interest over 30 years.
- In your first full year, you’d be paying about $13,935 in interest and $2,031 in principal.
- You have property taxes of $4,000 per year.
- You’re married, and eligible for a $27,700 standard deduction.
Your two big deductions are your mortgage interest and your property taxes. We’ll assume these are your only two, but individual situation may vary. In this example, this would equate to a total itemized deduction of $17,935. You’d have to claim an additional $9,765 in tax deductions just to break even with the standard deduction.
In the process, without additional deductions, you will have paid $17,395 that you’ll never get back in order to lose tax benefits!
And what if you have a smaller mortgage, lower property taxes, or a mortgage with lower interest rates than this? Your “benefit” is even worse. Nobody would make that trade, of course, but it’s a highly realistic situation that shows you just how feeble the “buy a home for the deduction” advice is, particularly in a post-tax reform, higher standard deduction reality.
And the longer you pay off your mortgage, the less of your mortgage payment goes to interest – and the less you can deduct from your taxes. In other words, every passing year equates to a lower tax benefit. This is one of the reasons why I’m a fan of paying off your mortgage early.
This highlights the importance of running the numbers for your own situation before buying a home. You may find that unless you buy a very pricey home, the tax benefit for you is going to be minimal, potentially even negative compared to the standard deduction.
The reality is that the tax advantages that come from a mortgage interest tax deduction are over-rated at best and can actually be non-existent for some home buyers. And that’s, in part, why home ownership as the “American dream” is not all it’s cracked up to be.
Mortgage Deduction Discussion:
- Have you heard the advice of buying a home for the mortgage tax deduction?
- Have you bought a home based on this advice?
- What factors would you recommend when considering whether to buy a home?
I know there are states that don’t have income tax, but in those that do, income tax is easily bigger than the property taxes. Good thing I get to deduct both of these in addition to the mortgage interest deduction.
My opinion is don’t buy the house for the mortgage deduction, but as long as you are buying don’t forget to use every tax incentive available.
Someone once told me tax deductions were like paying a dollar to save 25 cents (if you’re in the 25% bracket). Better off not paying all that interest in the first place.
The set of numbers used in the posting are unrealistic for many people. I recommend rewriting this post assuming the person lives in a high income tax, high property tax state where the average homeowner has a mortgage over $400,000. I’ve lived in Southern CA and Northern VA. California taxes and home prices are much higher than in VA and yet in both places I’ve always itemized and the amount has been WAY over the standard deduction. The post is too simplistic. You need to run the numbers for your own situation, determine the extent of your personal mortgage tax deduction benefit and then make decisions taking that number into account.
I actually kind of agree with this statement. I love this blog and I learn a ton from the examples, but it does seem like many of the examples are based on midwestern numbers. I know when we’ve discussed grocery costs, transportation, housing costs, etc, I am always amazed by how small the numbers are compared to what things actually cost along either coast or in the mountain west. GE – when you did your poll earlier in the year, did you get a sense of the geographic locations of your readers? If you have a good base in coastal areas, you may consider using costs that are more realistic to this population segment.
” You need to run the numbers for your own situation, determine the extent of your personal mortgage tax deduction benefit and then make decisions taking that number into account.”
I agree and did make that statement. The calculation in the post is meant to be an eye opener, not a one-size-fits-all. However, even if you have a $600k mortgage, is paying $30k a year in mortgage interest so that you can get 15-35% of it back a good deal? The mortgage tax deduction should never be a primary reason to buy a home.
I think you have fair points, but are making this argument way too simplistic. Sure, paying $1 to save $.25 is dumb, but you have to consider that you “earn” equity in the home as it increases in value. For the sake of easy math, say you buy a $100,000 home and put 10% down. The property in 1 year increases in value by 1%, so you’ve now “earned” $1,000 by doing nothing other than paying what you may be paying for rent anyways. A 10% ROI (in one year) is pretty good on an investment you pay 0 capital gains on when you sell.
You’re assuming housing prices go up every year? Tell that to someone who bought in 2007 and tried to sell a few years later.
I did an experiment after reading this article and Misha’s comment. I went to Turbotax and deleted the mortgage amount listed on my 2012 taxes to see what would happen. Fed taxes increased $6500 and state taxes increased $1000, so the mortgage deduction “saved” me $7500 in taxes last year. While it certainly isn’t the reason I bought a house, it goes to show that there is a big difference in what the tax break provides to different taxpayers and why it would really hurt some of us to have that deduction disappear. I agree with you that it isn’t the reason to buy a house, but in a high tax state with expensive housing and, of course, a big mortgage, it can have a huge impact on taxes. Interesting article GE!
You are basically correct.
The thing (mathematics) you kinda touched on with previous posts is this:
Over the anticipated ownership period:
M + I + T < R
M = Total Maintenance Costs
I = Total Mortgage Interest
T = Total Property Taxes
R = Total Rental Cost
You may estimate inflation in maintenance costs and taxes of ~5% and rent of ~$600 per year as this will be conservative in most cases to see if it all works out.
Further, assume the anticipated ownership period to be a maximum of 5 years for this calculation (same as Edmund's cost of ownership over 5 years) because longer term predictions are less accurate and probability of ownership over long term may reduce substantially.
G.E. – It seems a little ridiculous that you make mortgages out to be “highway robbery” because you pay more interest at the beginning than you do at the end. Why wouldn’t you have a larger portion of your payment go to service interest when you have the most money borrowed (at the beginning of a mortgage). The interest paid is the cost of using someoneelse’s money. If you are using a lot of it, you will pay more. If you are using less, you should pay less, and that is exactly what happens.
exactly. I had the same thought
Yeah… We were looking at purchasing a house before the Fed raises interest rates, but now we’re not sure it’s just worth it. If we were to buy a house in July with a $332,500 mortgage at 4.375%, according to a basic amortization schedule, we would be pay around $6,000 in interest between August and December, plus an additional $1600 in property taxes. Even if we were to deduct our state income tax, which came to about $7000 last year, the total amount we could deduct would be somewhere around $14,600. The standard deduction is $12,600. That’s only a 2,000 difference. We’re in the 25% federal tax bracket, so our refund would be $500 or about $100 per month for the rest of the year.
Both prices and interest rates have been rising fast, but we’re hoping the increases will slow before the end of the year. It looks like we would save a lot more in taxes by waiting until Jan. 2016 to buy our first house.
A lot of this depends on what tax bracket you are in and what state you are in… nevertheless I think you did a great job of explaining your point!
From an emotional standpoint, paying off a mortgage early allows a lot of people to sleep better. From a financial standpoint, having $1M+ in an investment portfolio and a $1200/mo mortgage allow a lot of people to sleep better. It’s 100% personal. One thing we forget is you have to pay property taxes even if you pay off the mortgage so the “real” mortgage payment is minus property taxes (and insurance most times). Throw in inflation and a $1200/mo payment deflates 60%+ over 30 years while rents and housing prices ballon 60%+.