Using Mortgage Interest As An Itemized Deduction

What is mortgage interest and how to deduct mortgage interest on taxes? Mortgage interest is any interest you pay on a secured loan when you buy your first or second home. The loans include the mortgage to buy a home, a second mortgage, a line of credit or even a home equity loan. The loan has to be secured debt or it will be considered to be a personal loan and it will not have a deductible interest.

For the average consumer who has managed to acquire credit card debt, car loans, and other small debts, is the mortgage interest (especially an interest only loan) a solution to mortgage interest deductions and the elimination of non deductible interest? 

What options does an average consumer have to accommodate the tax need in relation to the housing need?  How about the interest only loan option on a new house mortgage?  Today's housing and mortgage market has seen a significant increase in mortgage packages, variety and amount.  The mortgage interest deductible on the interest only loan option, when it's believed to have gone the way of the Edsel automobile, is back today and being used a lot.  The mortgage market has experienced a huge increase in the interest only loans from just a mere sliver of the market several years ago, to around twenty five percent of the market share today.  This represents a very big growth, especially when it takes less than five years to achieve that increase. 

What advantage does the mortgage interest (especially the interest only loan) bring to the table, and will this be benefitting the homeowner as a taxpayer?  This is one question that the mortgage lender won’t be able to answer for you, and one you probably won’t think about asking.  But you should, because it is one question that can make a difference to you and to your federal tax return and the amount of mortgage interest which will really give you a federal income tax deduction.  A mortgage interest deduction is one of the best financial reasons to buy a home.  Who will get the deduction?  You get the mortgage interest tax deduction, if you are the primary mortgage borrower, legally required to pay the debt and actually make the payments.  For married couples, if they both signed the loan, then both of them are the primary borrowers. 

The interest only loan and the amount of interest you can deduct on your income tax return are one and the same if your income levels are sufficiently low; the concern for the average consumer is the total dollar value they are able to get from their tax return.  In many cases, the tax deductions for the consumer aren’t enough to help with the bottom line, because the income level the percentage of deductible interest is calculated on is simply too high.  A higher dollar amount in interest often means a better possibility of a higher tax deduction.  There can be tax deduction limits for mortgage interest.  Your tax deduction is limited if all mortgages on your home are either more than the fair market value of your home or more than one million dollars ($500,000 if married and filing separately). 

The greater deduction would be the only benefit of an interest only home loan as far as the taxpayer is concerned, except in cases where, they use the money saved from the interest only loan to fund a 401k, an IRA, or an MSA (this is a topic for a very different paper).  The mortgage interest and particularly the interest only loan is sold to the consumer as a way to afford more house, pay off credit card debt, or provide a means to fund a savings of some sort, in case thats true, it may be used for that purpose.  And when you’re considering paying off high interest credit cards, the mortgage interest you’re charged on the interest only loan is fully tax deductible, while the credit cards are not; a word of caution, however, make sure you don’t go back and use those credit cards again, putting yourself right back where you started from, just with a higher interest payment and less house equity. 

What is the reason that the market has experienced this kind of growth?  It’s not entirely associated with the income tax benefit; the home mortgages in the present day satisfy a common desire for the consumer: instant gratification of bigger and better.  This is the case when it’s time to make those needed house repairs, or expansion.  A second mortgage can help you secure the same monthly mortgage payment, whilst still being able to pull a lot of equity on your home.  This can seem like the ultimate solution, but is it really?  It also adds to the amount of interest an individual can deduct at the end of the year; and when the income levels are growing, the interest expense must grow in order to keep up.  Now, that is a fairly skewed strategy for exploring the benefit of a mortgage, but it figures directly into the same scheme as the elimination of credit card debt and saving for 401(k) s as a justification for borrowing money against your home. 

Remember that your home mortgage has to be a secured loan from your main home or second home.  You will not be able to get a tax deduction out of your mortgage if it is for a third home, fourth home and so on.  The mortgage and the resulting interest are great resources, if they are used by the right people, in the right situation.  For the typical consumer and long term homeowner, unless you think a better deduction on your tax return is worth the forfeiture of equity in your home, you’d better think twice before refinancing with a second mortgage that generates more interest, but less equity.