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If you’re a homeowner who paid taxes last year, then you likely already know about mortgage deduction changes under the new tax law. But it’s almost tax time — again — so it might be time for a little refresher.
Check out this primer on the 2019 mortgage interest deduction with expert tips… and make sure you’re ready with all the info you need to know so you don’t make any mistakes, and so you get back all the money you’re entitled to — fast.
The basics: What is a tax deduction?
A tax deduction is a deduction across any category that lowers your taxable income, and as a result lowers your tax liability — or the amount you owe at tax time. Deductions are usually expenses that you incur throughout the year that you can rightfully subtract from your total income to determine how much you owe in taxes.
What’s the mortgage interest deduction?
The mortgage interest deduction is a tax deduction you can take for mortgage interest paid on the first $1 million of mortgage debt during that tax year. Homeowners who bought houses after December 15, 2017 can deduct interest on the first $750,000 of the mortgage. This doesn’t include the principal payment or your insurance. (FYI, property taxes up to a certain amount are deductible, too.)
Qualified property types include a house, condominium, co-op, mobile home, house trailer, boat, “or similar property that has sleeping, cooking, and toilet facilities,” according to the home mortgage interest deduction tax code.
To claim this deduction, you must itemize your tax return.
How do I itemize my return to claim the home mortgage interest deduction?
“Itemizing basically means listing out your deductible expenses, and taxpayers have to choose between itemizing and claiming the standard deduction,” says NerdWallet tax specialist Andrea Coombes.
Consider that the standard deduction for 2019 is $12,200 for single filers and $24,400 for those who are married and file jointly. That means your combined deductible expenses, including things like property taxes up to $10,000, mortgage interest, charitable contributions plus some other expenses, would have to exceed $12,200 for singles and $24,400 for married couples for it to make sense to itemize.
“For example, say you’re single and you paid property taxes of $3,000 and mortgage interest of $15,000 on a mortgage loan of $365,000 in 2019. You can use that $18,000 of property taxes and mortgage interest as a deduction, to reduce your taxable income and thus trim your overall tax bill,” Coombes explains.
“Now, if you’re married and in the same situation — $3,000 in property taxes and $15,000 in mortgage interest — you’re better off taking the standard deduction, unless you have other deductible expenses that add up to more than the $24,400 standard deduction amount for married couples.”
A word to the wise, suggests Gregory Brown, a top-selling agent with Century 21 Bradley based in Fort Wayne, Indiana:
“If you don’t have enough itemized deductions, then you’re better off just taking the blanket standard deduction. I strongly recommend at least talking to a tax professional. You can interview accountants for free.
“And when you’re getting into homeownership, and you’re donating to charity, then you’ve got your kids’ 529 accounts for college, and you’re doing a Roth IRA, you really need to be talking to a professional because there are so many different pieces to the puzzle.”
Noting that basic tax preparation might cost around $1,000, Brown says: “The money you can save for talking to one of those guys — you’re going to make that up.”
How does the mortgage interest deduction work in the real world?
You can now deduct interest on the first $1 million of your mortgage, or $750,000 for homes bought after December 15, 2017. But because most homes around the country cost less than $750,000 (according to Census data), the number of homeowners actually affected by the change is pretty small.
Also, consider that your biggest interest deduction will come in your first year of homeownership, and your deductions will get smaller every year after that.
Here’s how — and why — that works: Every mortgage loan amortizes. Over time, the payment amount stays the same, but as you go, it consists of less interest and more principal than the payment before.
“In the first years of a mortgage loan, the reduction of the interest payments is gradual,” according to NerdWallet’s Coombes. “That is, the value of the mortgage interest deduction does fall over time, but there’s not much of an effect in the first few years of the loan.”
Let’s use BankRate’s amortization calculator to give some real-life examples of how much somebody who closed on a house in January could expect to deduct. Let’s say you took out a $250,000 mortgage, getting a conventional 30-year fixed loan at a rate of 4.625%. With a monthly payment around $836, you’d pay about $7,371 in interest in this first year — that’s your deduction.
For next year, you’d be looking at a deduction of $7,248… and so on over time, with deductions continuing to shrink.
Now let’s say you took out a $600,000 mortgage in January, with the same terms. With a monthly payment around $3,085, you’d pay about $27,551 in interest in this first year. For next year, you’re looking at a deduction of $24,847.
Tax implications aside, there’s major satisfaction in paying on a mortgage loan over time, and watching your equity bloom as your payments shift from heavier on the interest to heavier on the principal.
“When you look at those amortization scales, for every $100,000 you’re increasing about $1,000 to $1,500 a year, and then that adds on to the back end. So after the first year, you get $1,000 to $1,500, then you’re around $3,500, then you’re around $6,000,” Brown estimates.
“So it really starts to snowball even though your payment is staying the same. More and more of that payment that is going toward paying off your mortgage and not just interest. That’s the beauty of it.”
(Yes, even if your tax benefit fades!)