For the majority of homeowners, mortgage loans are the largest source of debt they will take on in their lifetime. This does not, however, discourage the millions of potential homebuyers from considering this financial obligation. In fact, the federal government ensures that homeownership remains a possibility and goal for many by offering significant tax breaks on their mortgages. Here’s everything you need to know about tax deduction qualifications, as well as how to maximize them.
How Many Mortgages Qualify For Mortgage Tax Deductions?
You can qualify two homes to receive the tax benefits: your primary home and any second home. Whether you have one or two qualifying mortgages, the same total tax deduction limit will apply to both homes.
How Much Interest Can You Deduct From Your Mortgage?
The largest deduction is the mortgage interest deduction, which is only available to homeowners who itemize deductions on their tax returns. This allows them to reduce taxable income by the amount paid on mortgage interest. There are two borrowing limits for mortgage interest deductions:
- Home Acquisition Debt: Home acquisition debt refers to money borrowed to buy and/or upgrade your home. The total limit for this kind of deduction is $1 million, meaning you could only deduct the interest accrued on this first million on mortgage loans. If you file a separate return from your spouse, then this limit decreases to the first $500,000—and remember, this total would apply to both homes (if you qualify two mortgages). For example, if you have a mortgage on your primary home for $600,000 and a mortgage on your second home for $300,500, then all of your interest will be deductible because the total $900,500 is less than the $1 million limit.
- Home Equity Debt: Home equity debt covers a variety of smaller borrowing purposes. As a result, the total limit is much smaller—capped at $100,000. If you need to borrow more, then a prorated amount of your interest payments will receive the deduction.
What Counts As Mortgage Interest?
Mortgage interest is formally defined as “the percentage charged on a mortgage that must be paid in addition to the principal.” According to tax law, certain provisions apply for paying mortgage interest. One provision is including mortgage points, or prepaid interest that is due upon closing to lower the interest rate of your mortgage. In most cases, mortgage points are deductible the year that you purchase your primary home. You may also deduct them ratably throughout your repayment period.
Does Refinancing Affect Mortgage Interest Deductions?
Refinancing only affects mortgage interest deductions if you increase the principal mortgage amount. For example, if you owe $300,000 on your original mortgage and refinance it with another $300,000 mortgage, then the $300,000 will remain home acquisition debt. If you decide to refinance with a $400,000 mortgage, however, then the added $100,000 will become home equity debt.
How Do You Claim Mortgage Interest Deduction?
As previously stated, you must itemize your deductions in order to claim the tax benefits. To do this, you will need to file your taxes using Form 1040 and Schedule A to report any itemized expenses.
Overall, mortgage tax reductions are available to help you save on your home—it’s just a matter of understanding the qualifications. For more information about how to maximize your mortgage tax reductions, or to learn more about home financing, contact one of our mortgage specialists today.