The mortgage interest tax deduction is one of the most cherished American tax breaks. Realtors, homeowners, would-be homeowners, and even tax accountants tout its value. In truth, the myth is often better than reality.
Calculating The Mortgage Interest Tax Deduction
Most Homeowners Now Get Nothing
The Tax Cuts and Jobs Act (TCJA) passed in 2017 changed everything. It nearly doubled standard deductions, making it unnecessary for many taxpayers to itemize. Result: Most went on to forgo use of the mortgage interest tax deduction entirely. For the first year following the implementation of the TCJA, an estimated 135.2 million taxpayers were expected to opt for the standard deduction. By comparison, 20.4 million were expected to itemize and, of those,16.46 million would claim the mortgage interest deduction. There are more than 80 million mortgages outstanding in the U.S., which suggests the vast majority of homeowners receive no benefit from the mortgage interest deduction.
The mortgage interest tax deduction is perhaps the most misunderstood aspect of homeownership. It has taken on near-mythical status, to the point where many would-be homeowners are sold on the benefits before they even examine the math to determine their eligibility. Underlying the myth are two primary misconceptions: The first is the mistaken idea that every homeowner gets a tax break. The second is that every dollar paid in mortgage interest results in a dollar-for-dollar reduction in income tax liability.
The Mortgage Interest Deduction Now
Misconception 1: You Will Get a Tax Break
Despite the hype, the overwhelming majority of homeowners receive no tax break at all from the mortgage interest tax deduction. Keep in mind that in order to even qualify for the deduction, homeowners must itemize their deductions when determining their income tax liability. Itemizing provides an opportunity to account for specific expenses, including mortgage interest, property taxes, and partial medical expenses. As mortgage interest is often the largest of these expenses that a taxpayer pays, deducting it is often cited as a financial incentive to buy a home.
Once again, while an attractive idea in theory, the reality is that passage of the TCJA means that itemizing deductions no longer makes sense for most people. For taxpayers who are single or married but filing separately, the standard deduction is $12,200 in 2019 and $12,400 in 2020. For heads of households, it is $18,350 in 2019 and $18,650 in 2020. For married couples filing jointly, the standard deduction is $24,400 in 2019 and $24,800 in 2020.
Taxpayers who do not have deductions that add up to more than the standard deduction amounts would not need to itemize, and therefore derive no tax benefit from paying interest on their mortgages. Don’t forget, in 2018, just 16.46 million taxpayers were estimated to take the mortgage interest deduction (out of the 154 million returns that were processed). For 2019, the number of taxpayers expected to claim mortgage interest is estimated to drop to 14.35 million filers.
Misconception 2: It Will Be a Hefty Deduction
Even for homeowners who itemize their taxes and qualify for the mortgage interest tax deduction, the amount of the deduction is a mere fraction of the amount of interest paid on the mortgage. Once again, a little number crunching is required to fully comprehend the situation, because the deduction is not a tax credit.
You don't get a $1 tax break for every dollar spent; you get pennies on the dollar. Unlike a credit—which provides a dollar-for-dollar reduction on actual tax amounts owed—the mortgage interest deduction reduces the amount of total income subject to tax based on the taxpayer’s tax bracket.
For a simplified example, a taxpayer spending $12,000 on mortgage interest and paying taxes at an individual income tax rate of 24% would be permitted to exclude $12,000 from income tax liability, resulting in a savings of $2,880. In effect, the homeowner paid $12,000 to the bank in interest in order get less than a fourth of that amount excluded from taxation.
Spending $12,000 to reduce the amount of money you will pay taxes on by $2,880 simply makes no sense. Worse yet, an honest assessment of the actual bottom-line savings should factor out the value of the standard deduction. The table below provides a comparison.
|Taxpayer Status||Standard Deduction
|Value of Standard Deduction in 24% Tax Bracket||Value of Mortgage Deduction on $12,000 in Interest||Bottom Line: Difference Between Standard Deduction and Mortgage Deduction|
|Single||$12,200||$2,928||$2,880||$48 in favor of standard|
|Head of Household||$18,350||$4,404||$2,880||$1,524 in favor of standard|
|Married||$24,400||$5,856||$2,880||$2,976 in favor of standard|
Using our $12,000 mortgage interest example, a married couple in the 24% tax bracket would get a $24,400 standard deduction in 2019, which is worth $5,856 in reduced tax payments. If the couple itemized their deductions on Schedule A, the mortgage deduction would come to $2,880. The couple would get the tax reduction value of the standard deduction even if they do not have a mortgage. The difference between the two—the tax break gained by paying $12,000 real dollars to the bank in mortgage interest—would be a loss of $2,976. Taking the standard deduction would be the far wiser course of action than itemizing just to receive the mortgage interest tax deduction.
Even taxpayers in higher tax brackets would get no benefit, unless they have other high dollar value deductions to itemize. A taxpayer spending $12,000 on mortgage interest and paying taxes at an individual income tax rate of 35% would receive only a $4,200 tax deduction. That’s slightly less than what the taxpayer would receive from taking the standard deduction. The “benefit” of the mortgage interest deduction is shown on the table below.
|Taxpayer Status||Standard Deduction (2019)||Value of Standard Deduction in 35% Tax Bracket||Value of Mortgage Deduction on $12,000 in Interest||Bottom Line: Difference Between Standard Deduction and Mortgage Deduction|
|Single||$12,200||$4,270||$4,200||$70 in favor of standard deduction|
|Head of Household||$18,350||$6,423||$4,200||$2,223 in favor of standard deduction|
|Married||$24,400||$8,540||$4,200||$4,340 in favor of standard deduction|
Structured this way, it is not surprising that a tax deduction arguably put in place to encourage home purchases tends to be used primarily by higher-income households. Of the 14.35 million taxpayers in 2019 who are expected to claim the benefit in 2019, 10.56 million are in households earning $100,000 annually or greater.
Additionally, there is a limitation in place on how much of your mortgage interest can can be deducted. For 2019, the limit is the mortgage interest paid on the first $750,000 of indebtedness for a married couple or $375,000 for a single taxpayer. A slightly higher limit exists for indebtedness that was incurred prior to December 16, 2017 ($1,000,000 for married filing jointly and $500,000 for single taxpayers).
A Better Way
Rather than spending large amounts of money on interest for little in return, you would be far better off paying cash for your new house. A cash purchase will save you tens of thousands of dollars because you will not be paying interest.
Of course, there’s always the argument that you could make more money by paying the interest and investing the rest of your money in the stock market. It seems like a great strategy when the market is going up, but prognosticators giving that advice are nowhere to be seen when the stock market drops by 40%, home values fall by 40% and their investment advice leaves homeowners owing more on their mortgages than the home is worth.
As there is no investment out there that will guarantee better returns than the amount you would save by avoiding interest payments altogether, the conservative choice is clear. Avoid making interest payments if you can. Pay off the house quickly if you cannot.
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U.S. Congress, Joint Committee on Taxation. "Overview Of The Federal Tax System As In Effect For 2018," Pages 4, 36, Download "JCX-3-18." Accessed July 13, 2020.
Federal Reserve Bank of New York. "Household Debt and Credit Report (Q3 2019)." Page 4 Data. Accessed July 13, 2020.
Internal Revenue Service. "Topic No. 501 Should I Itemize?" Accessed July 13, 2020.
Internal Revenue Service. "IRS provides tax inflation adjustments for tax year 2020." Accessed July 13, 2020.
Internal Revenue Service. "Filing Season Statistics for Week Ending November 23, 2018." Accessed July 13, 2020.
U.S. Congress, Joint Committee on Taxation. "Overview Of The Federal Tax System As In Effect For 2019," Page 36, Download "JCX-9-19." Accessed July 13, 2020.
Internal Revenue Service. "Publication 936 (2019), Home Mortgage Interest Deduction." Accessed July 13, 2020.