This article was updated on May 25, 2017, and originally published on Jan. 11, 2015.

No tax deduction is more misunderstood than the mortgage interest tax deduction. By law, taxpayers can deduct interest paid on their mortgage, but many middle-class taxpayers save little or nothing at all from the mortgage interest tax deduction.

In fact, while the average savings is $1,918 across all incomes, those who earn less than $75,000 per year typically save $800 or less each year by deducting their mortgage interest. 

Photo of blue house

Modest homes provide only modest tax benefits. Image source: Getty Images.

How the mortgage interest deduction works

You can deduct all of your mortgage interest on up to $1 million in principal on the home in which you live. Thus, if you pay interest on a $250,000 mortgage, all of it is deductible. If you pay interest on a $1.5 million mortgage, only the interest on the first $1 million of principal is tax deductible.

But there are limitations. To qualify for the mortgage interest tax deduction, you have to itemize when you file your taxes. By itemizing, you forgo the standard deduction, which starts at $6,300 for singles and $12,600 for couples filing jointly. 

The standard deduction is a baseline. You can opt for the standard deduction, and not itemize, at your discretion. Thus, whether or not the mortgage interest deduction helps your financial being rests on whether or not it pushes you over the standard deduction.

Image source: Author.

Those with high incomes benefit most from mortgage interest deductibility. Chart by author.

Consider this scenario 

You and your spouse paid $10,000 of mortgage interest on your home this year. You also had $3,000 in other tax deductions. If you itemize, you'll be able to claim $13,000 in tax deductions. If instead you choose not to itemize, you'll get $12,600 just by virtue of being a married taxpayer.

Thus, the net effect is that only $400 of your deductions make a difference, since your itemized deductions of $13,000 exceed the standard deduction of $12,600 in this situation. If you end up in a marginal tax bracket of 25%, you'll save about $100 in taxes for paying $10,000 in mortgage interest -- not much more than a rounding error.

Tax savings for high earners

All in all, the mortgage tax deduction is a (lowercase "F") fool's game for middle-class earners in low-cost areas, and a boon for high-income earners in high-cost areas.

Someone who owns a million-dollar home and who pays interest on a $1 million mortgage will inevitably be able to deduct more of their mortgage interest than someone who pays interest on a $100,000 mortgage.

So, while the mortgage interest tax deduction is touted as one of the best reasons to buy a home, it often provides little help to people who don't live in a modern-day McMansion.

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