Calculate Your Mortgage Interest Deduction the Right Way
With the large deficit our country is facing, politicians are starting to get creative. There’s actually been some talk about getting rid of the mortgage interest deduction for homeowners. If you don’t own property, then you may not know about one of the biggest tax deductions available. The mortgage interest deduction allows taxpayers who own their own home to deduct the interest paid on their loan from their taxable income. The interest is deductible on the first $1 million of home acquisition debt and $100,000 on home equity debt.
In order to take advantage of this deduction, taxpayers need to calculate if their itemized deductions will be greater than the standard deduction on their Schedule A form. Younger homebuyers need to take this into account when planning out if buying a house is right for them. The NRA(National Realtor Association) loves to tell homebuyers how much they will save in taxes by buying a house. While this may be true, with lower home values it may not be as much as you think.
The Best Deduction Around?
The mortgage interest deduction is one of the best tax deductions out there and will almost immediately allow you to itemize your deductions, reaping the benefit of property tax deduction, medical expense deduction and charitable contribution deduction among others. Your CPA will love you and you will love him once you buy a house. A lot of deductions open up to homebuyers, but for property values in the sub 500k range, the deduction may not be as great as you think. Single taxpayers in 2012 are automatically granted a standard deduction of $5,950. When you itemize your deductions you lose this standard deduction. This might not make as much of a difference to someone with an 800k mortgage but when your mortgage is only 200k, removing the standard deduction will have a big impact on your finances.
Let’s take a look at an example:
Jay the homebuyer buys a property for $300,000. He puts down 20% and locks in a 3.75% 30 year fixed loan. On a $240,000 loan, Joe will pay $8,924.67 in interest after his first year. Let’s assume he makes $75,000; that would put Jay in the 25% tax bracket federally(we’ll ignore state taxes and FICA, Medicare, SS for simplicity). When I enter all this info into the mortgage interest deduction calculator on bankrate.com it tells me my first year tax savings is $2,231. Wow, that’s awesome!
The only problem with this number is it’s not true. Although you’ll be reducing your AGI by $8,924.67, you would have received the standard deduction of $5,950 without this. So your true savings is the difference between the total interest paid minus the standard deduction times your tax bracket. In this case, Jay is in the 25% tax bracket, so ($8,924.67 – $5,950) x 25% is $734.67. So in this case, your monthly savings is only $734.67 from the mortgage interest deduction and that’s a lot different than $2,231.
The Mortgage Interest Deduction is Still a Good Thing!
If you consider property tax deduction, which goes hand in hand with the mortgage interest deduction, you’re able to deduct an additional 1% of the purchase price(assuming property tax is 1% of purchase price). In the above example, this would be an additional deduction of $3,000.
But the key point to remember here is that you need to subtract the standard deduction from the total interest and property tax paid in order to get an accurate calculation of your savings.
The mortgage interest deduction is still a great benefit to taxpayers, but make sure you’re adding it up correctly. It ends up saving me around $125 per month on my taxes and it allows me to deduct all of my charitable contributions. As you get closer to the $1,000,000 limit, this will become less of an issue, but until then, I hope the government doesn’t get rid of one of the best deductions around.
Readers, have you taken this into account when adding up your tax savings from buying a home? Do these calculations makes sense or did you conservatively ignore this deduction?
-Harry @ PF ProTags: Deduction, Mortgage Interest, Mortgage Loan, Property tax