What Is a Mortgage Interest Deduction?

Saving up money for a down payment and closing costs has created a barrier for many would-be homeowners. To make it a worthwhile debt to incur, incentive programs were designed, like the mortgage interest tax deduction, which has made it even more attractive for renters to take the leap and incur the mortgage debt required to purchase their first home.

Another incentive is the FHA loan, which requires just 3.5% down, rather than the 20% required for a conventional loan. Since those incentives were introduced, things have changed. Is the mortgage interest deduction still the incentive it once was? Keep reading to find out.

In this article

    What is a mortgage interest deduction?

    A mortgage interest deduction is an itemized tax deduction homeowners can use to deduct interest on a qualifying loan they pay for using their taxable income. The loan might potentially be any of the following:

    • Mortgage loan
    • Home equity loan
    • Home equity line of credit (HELOC)
    • Second mortgage loan

    The loan is only eligible if used to build or purchase a home, or to make substantial improvements and updates to it. Homeowners can take the mortgage interest deduction on their primary and secondary residence, as long as they don’t rent out the second home full-time.

    Deductions like mortgage interest help people who own homes by lowering their taxable income, which lowers the total amount of taxes owed. By offering this deduction, often the largest single itemized deduction you can use, people are incentivized to purchase a home rather than paying rent to live in someone else’s home.

    Prior to the Tax Cuts and Jobs Act of 2017, the mortgage interest deduction was capped at $1 million in mortgage debt. Once the Act was enacted, the cap was reduced to $750,000 for homes purchased after Dec. 15, 2017. Homes purchased prior to that date were grandfathered in.

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    How does a mortgage interest deduction work?

    The mortgage interest deduction only works when you choose to itemize your deductions on your tax return. Homeowners are able to claim the mortgage interest deduction in 2021 by reporting the mortgage interest they paid in 2020 on the Schedule A portion of their 1040 tax form.

    Many homeowners don’t have mortgage debt close to the $750,000 cap on interest deduction, so the full amount of interest you paid in 2020 should be deductible if all requirements are met. If you choose to itemize your deductions to minimize your taxable income, don’t forget about home equity loans or lines of credit. Interest paid on these loan types is eligible too.

    You should receive a form 1098 from your mortgage or home equity lender stating how much you paid in interest for each loan type in 2020.

    Mortgage interest is deductible under the Tax Cut and Jobs Act until 2025, but some homeowners may be better off taking the standard deduction instead of itemizing when filing their taxes. Another part of the Act includes raising the standard deduction starting in 2019 from $6,500 to $12,000 for those filing individually and from $13,000 to $24,000 for those filing joint returns.

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    How does the mortgage interest deduction help?

    The whole point of offering a mortgage interest deduction was to encourage homeownership. By reducing your total taxable income, you’re able to lower the amount of taxes you pay. This is no different than a landlord deducting mortgage interest on their Schedule E for rental properties. Renters don’t have an option for interest deduction, so making mortgage interest deductible can make it worth the risk and cost of purchasing a home.

    Prior to the Tax Cut and Jobs Act of 2017, interest wasn’t the only cost eligible for deduction. You could also deduct items such as property taxes and percentage points paid on the mortgage.

    The Act was created to streamline the tax filing process and make it easier for individuals to prepare and file their own taxes. However, the increase in standard deduction amounts for single and joint filers has made the need for itemizing deductions unnecessary for many, as the standard deduction lowers their taxable income by more than their itemizations. The Act also limits the amount of state and local taxes (SALT) eligible for deduction to $10,000, including property taxes, which is set to expire in 2025 along with the mortgage interest deduction.

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    Mandy Sleight

    Contributing Finance Writer

    Mandy Sleight is a freelance writer and has been an insurance agent since 2005. She creates informative, engaging, and easy-to-understand content on the topics of insurance, personal finance, sustainability, and health and wellness. Her work has been featured in Kiplinger, MoneyGeek and other major publications. Learn more about Mandy and her writing on her website or by connecting on LinkedIn.