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How the Mortgage Interest Tax Deduction Works

        Money | Taxes

What Is the Mortgage Tax Deduction?

Established in 1913 along with the income tax, the mortgage tax deduction is one of the biggest tax deductions among Americans [source: McWhinney]. A deduction is just what it sounds like -- a sum of money you can subtract from your taxable income, therefore reducing the amount of taxes you have to pay to the IRS.

Mortgage interest is any interest on a loan secured by your home. (A loan is "secured" if the lender can sell the property if you don't pay back the loan.) Examples include:

  • A mortgage used to buy your home
  • A line of credit with your home as collateral
  • A second mortgage
  • A home equity loan

Personal loans don't count, because they're not secured by your home.

So, if you borrow money to buy, improve, or build your home, the mortgage tax deduction allows you to avoid paying taxes on the interest on that loan. Laura Adams of Money Girl provides a real-life example to make it easier to understand:

You purchase a home for $200,000 with a fixed-rate mortgage for 30 years at a 4.5 percent interest rate. Your payment for principal and interest on the home would be about $1,000 per month, or $12,000 per year. In the first year, the interest you pay on the mortgage would total $8,900. However, if you claim the mortgage interest tax deduction, $8,900 of your income won't be taxed. So that deduction can reduce the amount you owe, or, increase your tax refund

To learn how to claim the mortgage tax deduction on your taxes, keep reading.