How Can Mortgage Interest Be Good for Taxes?

Function

Your mortgage bank sends you a Form 1098 at the end of the year to document the amount of interest you paid. When you receive your Form 1098, you can itemize your income tax deductions using Form 1040 and Schedule A. The amount of mortgage interest you paid gets reported on Line 10 of Schedule A. This amount, added to your other itemized deductions, lowers your taxable income for the year, which is good for lowering your taxes.

To figure out how much money your mortgage interest deduction saves you on your taxes, you need to know your marginal income tax bracket. Your marginal income tax bracket is the highest income tax percentage you pay for the year. Then, multiply your marginal tax rate by the amount of interest you pay. The higher your income tax bracket, the higher your tax savings will be. For example, an $8,000 mortgage interest deduction saves you $2,800 if you fall in the 35 percent tax bracket, but only $1,200 if you are in the 15 percent income tax bracket.

If you claim your mortgage interest as an income tax deduction, you reduce the cost of your mortgage. To figure the after-tax cost of your mortgage, subtract the amount of your tax savings from the amount of interest you pay. This is the amount that your mortgage costs because your tax savings makes up for part of the amount you pay your lender. For example, if you pay $8,000 in interest, but it saves you $2,800, your true cost would only be $5,200.

If you do not plan to itemize your deductions, you should consider whether you would be better off not itemizing because in order to itemize, you cannot take the standard deduction. During the early years of the mortgage, you typically pay mostly interest during the first few years so you will save money by itemizing. However, if you are at the end of your mortgage, or started your mortgage in the last few months of the year, you might be better off forgoing your mortgage interest deduction in favor of the standard deduction. If the next year your mortgage interest deduction is greater, or you have other itemized deductions that make it worthwhile to itemize, you can itemize in a future year.