Deducting mortgage interest paid on tax returns is now a meaningful option for many borrowers
High mortgage rates in recent years have pushed many prospective homebuyers to the sidelines and seen others abandon their purchasing plans – but for those would-be buyers caught in two minds about taking the plunge, there’s at least a potential glimmer of relief amid the affordability gloom.
That’s the prospect of being able to deduct interest paid on their mortgage for federal tax returns, an option that previously made little sense for many borrowers during the low-interest-rate era that prevailed throughout the COVID-19 pandemic.
Borrowers who want to deduct mortgage interest payments for tax purposes must itemize their returns and need to have deductions exceeding the standard deduction to be able to do so.
In 2024, that standard deduction for a single person is $14,600, and $29,200 for a married couple filing jointly. Deductions being limited to $750,000 for homes bought after December 16, 2017 – and rock-bottom interest rates in 2020, 2021, and early 2022 – meant it often wasn’t possible for borrowers to itemize and deduct mortgage interest.
Deducting on mortgage rates ‘more meaningful’ than in previous years
Mortgage rates plunged at the onset of the pandemic, with the average 30-year fixed-mortgage loan in the US plummeting to 2.67% at the end of 2020 before beginning to spike in the opening months of 2022.
When rates were at those scarcely seen lows, the mortgage interest deduction, in addition to other items, wouldn’t reach the same level as the standard deduction. However, higher interest rates now mean it could be in homeowners’ interest to exceed the standard deduction, itemize their tax returns, and deduct interest paid on their mortgage.
Borrowers’ ability to deduct mortgage interest is now more meaningful than it’s been in years, Kevin Leibowitz (pictured top), chief executive officer and founder at Grayton Mortgage Inc. said – potentially presenting something of a “silver lining” with historically low rates off the table.
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The benefit of taking that option is clear. “You’re reducing your tax liability and in doing so, by virtue of owning a place, it’s one way to offset the hurt of higher interest rates,” he told Mortgage Professional America. “You’re making this deduction possible and then once you’re past that standard deduction, you now open up to a whole host of deductions on Schedule A which were not available to you when doing the standard deduction.”
When might the option be a good choice for potential homebuyers?
The option, of course, won’t make sense for every borrower. “It’s not just straight-line math,” Leibowitz said. “You have to factor in some of the other moving pieces to take advantage of that deduction when it comes up.” Still, for potential buyers who may be on the fence about making a move in the current environment, it can potentially provide some solace in a challenging market.
A good way of gauging whether those tax options make sense for the borrower is to ask their accountant to run taxes owning the place with the anticipated interest in real estate taxes – and then run it with and without, Leibowitz said. “Calculate the net difference in taxes owed or taxes refunded, and that’s the potential net benefit of owning this place compared to not owning and paying rent.”
Comparing the before-and-after tax effect of owning the mortgage interest can reveal big benefits: for illustrative purposes, $8,000 of taxes due versus getting a tax refund of $4,000 factoring in deductions, resulting in a $12,000 swing in taxes – amounting to $1,000 a month in tax savings, creating a lower monthly equivalent rent.
Prior to 2017, the maximum mortgage principal that could be deducted for tax stood at around $1 million – but that was whittled down by the Tax Cuts and Jobs Act (TCJA) passed that year. That measure also chalked off several tax deductions that could be combined with the mortgage deduction, reducing the incentive for taxpayers to itemize their tax returns.
Those changes are scheduled to expire after 2025, although they could be extended if Congress moves to renew the provisions.
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