The fact that mortgage interest is tax deductible has long been touted as one of the great benefits of home ownership. But it’s important to look at the mortgage interest deduction for it’s true benefit instead of simply assuming you’re getting a real tax benefit on all the interest you’re paying.
The Standard Deduction vs. Itemized Deductions
Home mortgage interest only gives you a tax benefit if you can itemize deductions. You’ll only want to itemize deductions if your total deductions are greater than the standard deduction. The standard deduction for 2010 is $5,700 if you’re single and $11,400 if you’re married. If your itemized deductions are less than those amounts, you’ll just take the standard deduction on your tax return.
Why does this matter? You’ll always have the option of taking the standard deduction – even if you never pay a thing that could be itemized (mortgage interest, property taxes, excessive medical expenses, etc.). Since you’ll always get the tax benefit of the standard deduction, itemized deductions only provide tax savings to the extent they exceed the standard deduction.
Here’s an example. Let’s assume you’re married and your marginal tax bracket is 15% (adjusted gross income between $16,700 and $67,900). If your total itemized deductions are $14,000, you’re not getting a true tax benefit of $2,100 (15% of $14,000). Even if you didn’t itemize deductions, you would have been able to use the standard deduction of $11,400. To calculate how much your itemized deductions are really saving you in taxes, you must first subtract the standard deduction – leaving you with $2,600 ($14,000 – $11,400) in this case. That means your itemized deductions are only giving you an additional tax savings of $390 (15% of $2,600).
When you’re talking about the potential tax savings of mortgage interest, you need to consider your standard deduction. If your mortgage interest combined with other itemized deductions isn’t going to push you over your standard deduction, then you’re not getting any tax savings at all. But even if it does, your tax savings should only be calculated based on how much your itemized deductions exceed your standard deduction. Before you let a Realtor or banker convince you of the great benefits of being able to deduct mortgage interest, make sure you take a close look at how much you’ll actually save.
Looking at your itemized deductions this way, how much are you actually saving on your mortgage interest? Let me know in the comments!