Mortgage Interest Deduction: Limits and How It Works

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A home is the largest purchase that most Americans will ever make, so most of them have to take out sizable loans to finance them. While mortgage interest rates are relatively low compared with other forms of borrowing, the interest can add up to hundreds of thousands of dollars over the life of the mortgage.

Fortunately, this interest can be deductible for some taxpayers. Unfortunately, you have to itemize deductions in order to benefit from this deduction. 

Keep reading to find out more about mortgage interest deductions, and how homeowners can benefit from this tax break.

What Is the Mortgage Interest Deduction?

The mortgage interest deduction allows those who itemize deductions on Schedule A to write off the interest they pay on their home mortgage. This allows them to reduce their taxable income and consequently pay less income tax. It’s important to note, however, that the deduction applies only to the interest portion of a mortgage payment, not the principal. 

Who Qualifies for the Mortgage Interest Deduction?

A main or second home qualifies for mortgage interest deduction — so if you have additional properties they would not be eligible except under special circumstances. The IRS defines a “qualified home” as any house, condominium, cooperative, mobile home, house trailer, boat or similar property that has sleeping, cooking and toilet facilities.

Note that there are size limitations to mortgage loans that could affect deductibility. Changes in legislation, such as the Tax Cuts and Jobs Act of 2017, have affected the limit over time, so it’s important to know just how much mortgage interest you can deduct.

How Much Mortgage Interest Can You Deduct?

Many Americans can deduct the full amount of their mortgage interest. However, the IRS does impose some limitations, based on the size of your mortgage and the date you took it out. 

• For mortgages taken out on or before Oct. 13, 1987: full deduction
• For mortgages taken out after Oct. 13, 1987 but before Dec. 16, 2017: $1 million home acquisition debt limit, or $500,000 if married filing separately
• For mortgages taken out after Dec. 15, 2017: $750,000 home acquisition debt limit, or $375,000 for married filing separately

Most homeowners — except those with mortgage debt that exceeds $750,000 — save money thanks to the mortgage interest deduction. To understand how it works, take a look at this mortgage interest deduction example: If you purchase a $400,000 home with a 20% down payment and take out a 30-year, fixed-rate loan with a 7% interest rate, you’ll pay $22,297 in interest during the first year, according to Allstate’s mortgage payment calculator. That could result in $6,164 in tax savings that year, based on calculations made by Allstate’s mortgage tax credit calculator. 

Bear in mind that as you pay down your mortgage, the amount of interest you pay decreases each year. Thus, your annual mortgage interest deduction will also decrease each year. 

How To Claim the Mortgage Interest Deduction

The process of actually claiming the mortgage interest deduction is fairly straightforward:

1. First, you’ll need your Form 1098 from your lender. This official tax form will show how much you paid in mortgage interest and points. 
2. Once you know how much your deduction could potentially be, compare it with the standard deduction to see if it’s worth itemizing or not. For tax year 2024, the standard deduction is $14,600 for single filers and married individuals filing separately, $21,900 for heads of household, and $29,200 for married couples filing jointly.
3. If your itemized deductions exceed your standard deduction, you’ll claim your mortgage interest deduction on Schedule A of Form 1040. 

Note that some other potential deductions related to your home may have to be claimed on different forms. For example, if you are deducting interest on rental properties, you must use Schedule E of Form 1040. If your mortgage funds your business – or if you are using part of your home as an office – you’ll claim those deductions on Schedule C of Form 1040.

Additional Tips for Maximizing Mortgage Deductions

In addition to mortgage interest, other home-related expenses may also be deductible, including points paid on a new loan, property taxes and mortgage insurance premiums.

Points

According to the IRS, mortgage points are essentially prepaid interest. This means you can’t generally deduct the full amount of your points in the year you paid them, although they are deductible over the life of the loan. But as the tax code is complicated, there are of course exceptions to this general rule. 

Specifically, the IRS uses this 9-point test to determine if points can be deducted in the year paid:

• The loan must be secured by a primary residence
• The practice of paying points must be the established business practice in the area where the loan is made
• The amount you paid wasn’t more than what points generally cost in your area
• You use the cash method of accounting
• The points weren’t substituted for other ordinary expenses such as inspection fees, appraisal fees, attorney fees, title fees, and property taxes
• The amount you paid at closing was at least as much as the points charged, and you didn’t borrow that money from your mortgage broker or lender 
• You use the loan you paid your points on to build or buy your primary home 
• The points were computed as a percentage of the principal amount of the mortgage
• The settlement statement must clearly show that the points were charged for the mortgage

Property Taxes

State and local real property taxes are also fully deductible. Property tax rates are determined by individual states and localities, so they will vary depending on where you live. Hawaii, for example, has the lowest property tax rate at 0.32%, while rates in New Jersey reach 2.23%. Rates in individual localities may vary slightly. For the average taxpayer, property taxes generally amount to at least a few thousand dollars per year. 

Mortgage Insurance Premiums

Private mortgage insurance is required if you make a down payment smaller than 20% of your principal balance. It is designed to protect lenders in the event that buyers are unable to make their mortgage payments. For many years, PMI premiums were tax-deductible, but this deduction expired in 2021. However, you may still be able to deduct your PMI, if it applies to a rental property.

Accurate record-keeping is essential if you’re looking to maximize your mortgage deductions. In addition to having the needed evidence in the event of an IRS audit, good record-keeping can also highlight all of the deductions that you qualify to claim.

Remember that if you refinance your mortgage during the course of a year, you’ll likely incur additional costs, and some of those may be deductible. You may want to consult a tax professional in this scenario to ensure you don’t overlook any qualifying deductions.

Gabrielle Olya contributed to the reporting of this article.

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